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In many ways, February was a month epitomizing the recent two-speed economy. Following the election, sentiment and survey measures surged, but the actual data trailed behind. Throughout February, the data remained in largely the same pattern. There are reasons to believe the optimism is warranted. But there is also room for skepticism around the timing of policy shifts and their immediate impacts.
The economic surprise indices also surged in late 2016, providing some credibility to the theory that growth and inflation were set to emerge. But beneath the indices, the economic data has remained fairly benign—except for survey based, “soft” data. Surveys are useful, but they are also anticipatory. For inflation to begin to accelerate sustainably, the underlying economy must be strong enough to justify it, and that takes real data.
The “hard” data—GDP, employment, inflation and so forth—has been relatively benign. Not too good, but not poor either. Similar to the pace we have seen over the past few years, U.S. GDP grew a disappointing 1.9% in the fourth quarter, but job creation in January was a better than expected at 227,000. Manufacturing growth in the U.S. was surprisingly strong for February, and the pace of inflation picked up, but wage gains were lackluster.
The economy itself has seen little acceleration, and this is capping inflation pressures for the time being. As new fiscal and tax policies become clearer and take effect, the economy may react by strengthening. With the soft data already reflecting a more optimistic picture, the hard data will likely be the primary driver of growth and inflation expectations from here.
One area of particular focus for the new administration is job growth, and there are reasons to believe that accelerating gains here will be a tall order. For this stage of the labor market, the U.S. economy is creating jobs at a healthy clip. As a result, the labor force participation rate is becoming an increasingly important driver of labor market health.
In fact, the Congressional Budget Office estimates there will be a steady decline over the next 30 years. This is driven by a few factors, but population aging is the most important. The Atlanta Federal Reserve broke down the factors to understand the recent decline in participation. Aging is responsible for over 2% with later retirement (extension of working life) actually offsetting a decline in the participation rate by a full percentage point (that will reverse eventually). Aging of the population is a secular force that is unaffected by a better economy.
As expected, the Fed held monetary policy steady at their meeting. Of note, there was little upgrade to the Fed’s assessment of the U.S. economy’s fundamentals with subdued comments about inflation moving higher and business sentiment picking up. There was no mention of balance sheet normalization, something observers thought might be a possibility. Both of these were fears going into the meeting—the Fed upgrading their view of the economy before the data stably backed it up and commentary around reducing the size of the balance sheet. Neither fear materialized. While a three-hike probability remains for the current year, the Fed is not in a hurry and is taking a wait-and-see approach.
The U.S. economy is on solid footing, but there is little evidence of a significant acceleration. A combination of tax cuts and regulatory reform could change the calculus quickly and dramatically. With such variability in potential outcomes, the Fed and other policy setting bodies would do well to continue to wait for the data to show the results of policies before acting.
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Quarterly and Monthly Notes
Third Quarterly, 2017
Second Quarterly, 2017
First Quarter, 2017
Fourth Quarter, 2016
Third Quarter, 2016
Second Quarter, 2016
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