For a few months at the end of 2017 and the start of this year there were two kinds of news coming out of Washington. One arriving at early hours nearly every day via Twitter was often disturbing, but without much economic import. The other, less frequent but more important, was announcements of actual actions – rolled back regulations, tax cuts and reform, a stimulative fiscal deal. These were mostly positive for the economy, at least in the short-run. Then about a month ago this pattern changed. The destructive Twitter news continues, but lately accompanied by destructive real actions – experienced moderate advisors replaced by more extreme voices and escalating tit-for-tat actions on the trade front that carry definite risks for the economic expansion. So far, however, the latter are not concrete enough to incorporate into our forecast, which is only a little less strong than last month.
The final release of data for the fourth quarter upgraded headline real GDP growth from 2.5% to 2.9%. Half of this increase was due to higher inventory accumulation and the rest to a higher estimate for consumer spending. The only other revisions of significant magnitude were a large increase in growth of investment in structures (from 2.5% to 6.3%) and a reduced guess for intellectual property investment (2.5% to 0.9%).
The broad picture remains unchanged. The economy came out of 2017 in a solid position. Consumption, investment, and housing were all quite strong. Exports were as well, although offset by growth in imports. And government spending was growing with the new fiscal package yet to come.
Monthly data released during March have tilted toward the negative, although not drastically, and with caveats.
On the household side disposable income grew moderately in February (after a large tax-cut induced increase in January), but consumption in both months was weak, falling in January and then flat in February. Consumer sentiment was off slightly in March, although remaining quite strong. Lastly, the household side of the employment report for March was disappointing. The labor force showed a decline, reversing a fraction of its large February increase. This allowed the unemployment rate to remain at 4.1% (six months straight) even though the household survey measure of employment was down by 37 thousand.
Data for business are similarly tinged with a slight negativity. Both ISM indexes declined in March, but only a little and like consumer sentiment remaining at elevated levels. After a very strong January, building permits and housing starts fell back considerably in February. Industrial production, however, had the opposite pattern – a strong February following decline in January.
Finally, March employment data from the establishment report was mostly below expectations. Employment rose just 103 thousand. The estimate for January was revised downward by 63 thousand to 176 thousand while February is now put at a huge 326 thousand (up 13 thousand).
In total all of this is a little confusing and indicative of a time of year when weather and seasonal adjustment often produce erratic data. However, except for the March payroll number, negative data changes were mostly small and remain at positive levels. Even the labor market data are pretty good if you focus on two or three month averages.
As can be seen in the chart, our updated forecast shows a little less growth during 2018 than in our outlook a month ago. For the just completed first quarter much of this is due to starting from a higher base in the revised NIPA data. Then our model carries this slightly weaker growth forward through the rest of the year. For Q1 we now put growth at 2.8%; for the rest of the year it is now 3.6%. Both of these numbers are about one-quarter percent below March.
Although down slightly from a month ago our expectation for 2018 and into 2019 is still for robust growth. Over the ten quarters from 2017:2 through 2019:3 we have output growth averaging 3.2%. This would be about 50% above the average for the first seven years of the recovery.
Our optimistic scenario is, unfortunately, far from a sure thing – farther than a month ago. There are many risks. Those we worry most about (in no particular order) are: (1) Inflationary pressure from a tight labor market, possibly with added pressure from tariffs; (2) Financial pressures from monetary policy uncertainty and large and rapidly rising fiscal imbalances; (3) Breakdown in the international trading system from policy brinksmanship driven by anti-globalism; (4) Total gridlock in Washington coming out of this year’s election.
We think the economy can probably muddle through this year and most of the next. Beyond that . . .