Real GDP rose a tepid 0.7% in the first quarter of 2017 after rising at a 2.1% pace in the fourth quarter of 2016. Four external factors artificially held down overall growth in the first quarter:
- A statistical glitch in the gathering of the data for the first quarter has been suppressing growth in the first quarter relative to the rest of the year for the better part of 20 years. The shortfall in growth, which somewhat arbitrarily shaved about three quarters of a percent from growth in the first quarter, is much more noticeable when the economy is growing at 2% or less than when it was cruising at much stronger pace. The economy was expanding much closer 1.5% pace excluding the glitch. The Commerce Department is (still) working to correct the problem. For now, it is best to average the first and second quarter; Growth for the first half of 2017 looks on track to come in at about 2%, which is better 2016.
- Wacky winter weather (unusually warm January and February followed by a wintery March) suppressed consumer spending. Spending decelerated across the board, but the largest hit showed up in nondurable goods; retailers couldn’t sell winter clothing when temperatures surged. We also saw a sharp slowdown in spending on services; outlays on utilities actually contracted in January and February.
- A delay in tax refunds by the now understaffed IRS (Treasury Secretary Mnuchin has argued for more hiring).
- Easter falling later than usual pushed much of the spending we usually see in the first quarter into the second. In fact, the rise in foot traffic at J.C. Penney’s was so strong at the start of April that the department store chain delayed closing some of the stores slated for the month.
We need to separate the secular shift from bricks to clicks and the ways consumers are spending as opposed to how much they will spending going forward. This transition has hit a tipping point and will affect how we assess spending ans employment in the months to come.
Inventories were drained at a breakneck pace during the first quarter; that drawdown shaved almost one full percentage point from overall growth in the first quarter and placed a substantial drag on business investment. That sets the stage for a rebound in the second quarter when inventories are replenished.
Underlying investment improved fairly significantly; investment in new machinery jumped 22%, underscoring the rebound we are seeing in the domestic shale industry added to renewed growth abroad. Exports picked up faster than imports, helping to narrow the trade deficit, which is a source of concern for the administration. Caterpillar’s first quarter earnings reports stressed the importance of the rebound we are seeing abroad for their bottom line, which improved dramatically in the first quarter.
The housing market was another bright spot, with an acceleration in both sales and construction. That bolsters our forecast for robust increases in consumer spending in the second quarter. Anyone who has ever bought a home knows what an incredible trigger to additional spending it can be, as new owners scramble to remodel and upgrade homes that they just bought. This is at the same time that anecdotal reports of cash-out refinancings are picking up, which should allow repairs and remodelling to homes neglected after the housing bust. A shortfall in new home construction, combined with delays in teardowns linked to foreclosures, boosted the average age of our existing stock of homes in recent years.
Government spending plunged with weaker defense outlays. This is something that the administration would like to change. Don’t hold your breath on a lot of new defense spending showing up in the spring, short of a military conflict. Even then, we are currently depleting bimb inventories with increased involvement in the conflicts in Syria and Afghanistan; that shows up as a drag instead of a boost to defense spending, until they are replaced.
The employment cost index (ECU), which many on the Federal Reserve favor as the best measure of compensation, jumped 0.8% in the first quarter, more than expected. The gain on a year-over-year basis was 2.4%, up a half of one percent from the first quarter 2016 pace. Growth in wages and salaries dominated those gains. Spending on benefits by employers picked up more modestly, particularly in the private sector. Compensation gains by sector were largest in the leisure and hospitality sector: up 4.3% from a year ago when another round of minimum wage hikes at the state and local levels took hold. Fewer immigrants also mean labor shortages. Immigrants play a larger role in this sector than elsewhere; complaints that workers afraid of being deporting not showing up for work are becoming more common.
Bottom Line: The “weakness” we saw in real GDP in the first quarter is a fluke, but unlike last year, it will be quickly corrected in the second quarter. The tailwind for consumer spending is particularly strong as we move from the first to second quarter and is already showing up in anecdotal reports from retailers, restaurant owners and resort operators. The only really persistent weak spot for consumer spending may be tourism, which has been affected by the strong dollar and more fears by foreigners of how they will be treated at the border. This is hitting high-end luxury retailers and resorts.