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April proved to be a bit of a reality check for US economic indicators and data. US economic data disappointed relative to expectations following several months of surging expectations. The recent GDP report from the Bureau of Economic Analysis revealed that the first quarter of 2017 grew at only a 0.7% pace. While the pace of growth is tenuous, there are few reasons to become overly concerned. The US should return to its now typical growth of around 2% in the second quarter as consumption rebounds and business investment continues to grow. The first quarter was a bit of a drag, but it should not be taken too seriously.
Particularly disappointing was job creation reported for March according to the Bureau of Labor Statistics. At only 98,000, it was far below the expectation for 180,000. But this is not too disconcerting given the still strong pace of job gains in the first quarter—averaging 171,000, a strong clip for this point in the cycle. This does point to a slower pace of job creation, but not a precipitous fall. Service-providing employment gains fell to only 61,000 in March but should reaccelerate.
Inflation was also weak in March, though it has been strong through the rest of the quarter. There were one-time factors including a significant drag from unlimited data plans for phones (seriously) which were a large portion of the month over month drag. Core-CPI was held up by shelter which accounts for more than 40% of the measure, any move lower would prove very difficult to overcome. For the time being, weak inflation can be chalked up to temporary and one-off factors. However, if shelter inflation begins to decline, it will become a much more persistent problem.
The first quarter inflation dynamic has far-reaching consequences. For the better part of 2014, inflation was growing at close to 2%, but, by early 2015, it was flat. Wage growth moved higher, from a trend of 2% to around 2.5%. This combination of near-zero inflation and slightly higher wage growth pushed real wage gains to near 2%. The fastest clip of the recovery—by far. Given the US economy’s heavy reliance on consumption, the tepidness of the current real wage growth is disconcerting. It has fallen back to near 0% as inflation picked up earlier in the year. During the rather lackluster growth of 2016, the contribution of consumption to GDP outpaced overall GDP growth (see chart on page 3) in three of four quarters.
So, the first quarter was a bit of a dud. But what about the second quarter? As stated above, consumption will lead the way. A typical, healthy reading is around a 2% annualized pace, and this should be achievable with lower inflation pressures. With consistent (even if slower) job growth and steady (hopefully higher) wages, consumption should not remain stagnant.
Further strengthening the case for a better second quarter and beyond is the recently outlined tax reform plan from the Trump Administration. Most of the details remain to be worked out, and it will be a lengthy process. With lengthy timeline in mind, the tax proposal would boost growth by more than some expect for a simple reason: pass-through tax rate deductions. Predominately small businesses and constituting the majority of employment, pass-through tax reform and reduction will have a direct effect on the vitality and dynamism of the US economy. Corporate tax reduction is important for larger businesses and will boost corporate profits. However, the translation to underlying economic activity will be minute in comparison to the pass-through effect.
One significant caveat is that a 15% corporate/pass-through rate is unlikely to make it through the legislative process. It is a good starting point, and tying corporate and pass-through rates together is an important development. If they remain coupled, even a final landing point of 20% would be a significant positive for the fundamentals of the US economy.
Tax reform is likely to take until the end of 2017 to pass, leaving plenty of time for the details to evolve. But there are reasons to believe the US economy will bounce back from a rather dismal performance in the first quarter to return to its trend pace of 2-2.5%. With tax reform of some kind likely late in the year, economic growth should continue at a reasonable pace. There is little reason to believe that the tepid first quarter was more than noise.
Source: BEA, Bloomberg
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Quarterly and Monthly Notes
Third Quarter, 2018
Second Quarter, 2018
First Quarter, 2018
Third Quarter, 2017
Second Quarter, 2017
First Quarter, 2017
Fourth Quarter, 2016
Third Quarter, 2016
Second Quarter, 2016
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