Uncertainty over the outlook and risks of political turmoil has surged in recent weeks, leaving global financial markets more cautious than we have seen in quite some time. This week, we take a closer look at what could roil financial markets and, more importantly, the economy.
Another Weak First Quarter
Real GDP growth looks like it will now come in at a 0.5% for the first quarter when the preliminary estimate is released on Friday. This is renewing concerns about the resilience of the U.S. economy. There are three factors behind the weakness, all of which are transitory:
- The Commerce Department has yet to correct a systematic undercount on the seasonally adjusted measure for first quarter growth. The “residual seasonality,” as it is termed, is shaving nearly three quarters of one percent off growth in the first quarter; that will show up later in the year. The problem is more than 20 years in the making, but much more noticeable when potential growth has slipped to 2% or less.
- Wacky winter weather, the unusual warm temperatures in January and February followed by winter storms in March, took a heavy toll on consumer spending.
- A delay in tax refunds moved much of the spending that would usually occur in the first quarter forward to the second quarter.
Why are the statistics so important? Because a misread on the first quarter could wrongly reinforce waning optimism. Economic fundamentals remain better than they were a year ago. The economy is poised to gain traction in 2017.
The First 100 Days.
The 100-day mark for the new administration is days away, which is increasing the pressure to rack up more “wins.” The White House is leaning on everything from tax reform to another vote to repeal and replace the Affordable Care Act (ACA). Republicans returning from a spring recess marked by hostile town halls are unlikely to move quickly on any legislation. The president may not be able to move legislation but he still has the power of executive orders, which could have a material impact on trade and immigration.
Another Government Shutdown? The push to find accomplishments for the president has also raised the risk of a government shutdown driven by the White House at a critical time. The continuing budget resolution expires on April 28. We are already six months into the fiscal year. Republicans and Democrats have been working on a compromise to keep the government going for the next six months but fear they might need a few more weeks of extensions to reach an agreement.
The administration insistence on adding funding to build a wall is not supported by members of Congress from states bordering Mexico. One result could be a government shutdown on the president’s 100th day in office, April 29th. The president’s Director of the Office of Management and Budget (OMB), Mick Mulvaney, has said that funding a border wall needs to be a part of the budget or the president may reject it. [Mulvaney is a former Tea Party conservative who pushed for the 2013 government shutdown.] A government shutdown backed by the White House could backfire and showcase the president as the problem, instead of Congress. That could drive a larger wedge between Republicans in Congress and the administration, further undermining progress on a pro-growth agenda.
The president has said that he would make a major announcement on tax reform this week. Treasury Secretary Mnuchin echoed that when speaking at the International Monetary Fund, arguing that details of tax reform would emerge “soon.” He also said tax cuts would “pay for themselves,” a claim that a prominent Republican economist and former Director of the Congressional Budget Office, Doug Holtz-Eakin, quickly dismissed. Tax cuts have never been proven to pay for themselves but can add to growth.
Much like health care reform, tax reform is complicated. That is why we haven’t seen it in thirty years. Moreover, it took three years (some argue longer, given the need to build a consensus) to get it done under President Ronald Reagan in 1986, back when Republicans and Democrats were still talking to each other. If the White House does make an announcement on tax reform this week, take it with a grain of salt. Those who would have to move it through Congress are not there yet.
Soft vs Hard Economic Data
We have a lot of survey data due out this week on both the state of manufacturing and the consumer. The “soft” data, as it is called, is likely to show solid if not spectacular growth. Manufacturing gains stem from the rebound in the shale industry and a pickup in exports since growth abroad has firmed. Consumer attitudes should remain bullish, especially now that tax refunds have arrived. The rub could be in consumer expectations. Increased tension with North Korea over the Easter Holiday may have had a dampening effect.
New home sales are expected to remain well below demand and could actually lose ground because of unusually bad weather during March. New home sales are booked once an offer is made, as opposed to closing, as in the existing home market. The key will be to look for an increase in sales of additional entry-level properties. The premium for new over existing homes remains large, but builders have been saying recently they will move downstream. Pending home sales are expected to remain red hot with buyers rushing to lock in lower rates in April. Prices are expected to continue to rise rapidly given the small stock of housing available. We will be looking for a broadening of price increases to second-tier and suburban markets.
The trade deficit is expected to remain largely unchanged for March, while durable goods orders should show another boost from the volatile aircraft sector. Core durable goods are expected to post a modest gain after falling a bit in February. Spillover effects from shale investment are becoming more apparent.
Political posturing can’t change the reality that much of what market participants expected to see done quickly will actually take much longer. That is upping the ante on policies like trade and immigration that can be changed quickly but could have dampening effects on growth. The challenge is that many of the risks we face are fat-tail risks, which are most difficult to price in.
Debates in Washington used to be little more than background noise for the economy but talk of new policies and uncertainty about them is almost deafening. Developments this week could exacerbate the uncertainty, increase volatility in financial markets and challenge the herd-like optimism among retail buyers who jumped in after the election.