Economic data during the past month have been mostly positive. This objective information has produced a stronger outlook from our model for the next year and a half. Subjectively, however, we think that this optimistic shift may be suspect.
The third release of data for first quarter was little different from the second estimate a month ago. Total real output growth was raised by 0.2% to 1.4%. While still a weak number, it is twice the initial estimate. Final sales growth for the quarter was revised up to a healthy 2.6%. The gap between final sales and total output measures the extent to which a drop in inventory accumulation held back the latter. At a disaggregate level the quarter was led by investment, both nonresidential (i.e. business) and residential (i.e. housing). Although down from the second estimate each still had a double-digit gain. Other sectors were less positive. Consumption was revised up to a still disappointing 1.1% growth. The weakness was primarily in spending on goods. In the trade accounts exports were strong, but imports also rose. This left the net export deficit nearly unchanged. Finally, government spending was weak with a large decrease in federal defense purchases, but also a small negative at the state and local level. Overall, still a weak quarter, but a lot better than the advance estimate two months ago.
Monthly data during June were about evenly split between good and not so good until last week’s employment data for June, which shifted the balance to the positive side.
That report had payroll employment up by 222 thousand for the month, with another 47 thousand added in revisions to the April and May numbers. There were increases in every sector except manufacturing (which was flat) and information services. Government employment rose 35 thousand, mostly at the local level. In the household survey there was also a nice employment increase (245k), but not enough to keep up with an increase in the labor force, causing unemployment to tick up to 4.4%. Overall a report that is consistent with a further tightening labor market, except with little sign of wage pressure – average hourly earnings were up just 2.5% from a year ago. This is pretty much where they have been for some time.
There is little sign of price pressure either. The personal consumption price index (either in total or excluding food and energy) was up 1.4% in May from May 2016. That was down from the previous month, and is well below the Fed target of 2%. This disinflation trend is, moreover, a global phenomenon.
Two other indicators of note: (1) Both ISM indexes were up significantly in June and both are at levels indicating considerable strength in the business sector. (2) May housing starts were lower for the third consecutive month, falling below a 1.1 million rate. This is inconsistent with continuation of the strong residential investment growth seen in the first quarter.
Overall the June data are strong enough to indicate some bounce in the second quarter from the weakness in Q1.
The harder questions are, first, how much bounce, and, second, will there be carry through beyond Q2? Our answers, as shown in the diagram, are yes on both counts. For the just completed second quarter we now put growth at a robust 3.6%. This is up 0.2% from last month. Our forecast is higher than most others. The Atlanta Fed Q2 nowcast is currently at 2.7%; that of the NY Fed is just 2.0%. Our model’s optimism continues through the rest of this year and into 2018. We put second half growth at 3.0% and 2018 at 2.4%, both 0.2% higher than in our June outlook.
Recent data have been generally positive, and our forecast is optimistic. The latter outcome is not due to judgmental input on our part. If all such changes are removed, the resulting No-Add forecast through 2018 is higher than our baseline by nearly 0.5%. This leaves us uneasy. The economy does not feel that good. It feels more like an impending “Gotcha.” Two candidates for disappointment: weakness in housing and in business investment (perhaps from a replay energy retrenchment).