Quarterly key points
- U.S. GDP growth softened to 2.0% in the first quarter, weighed down by slower personal consumption growth of just 0.9% (vs. 4.0% in 4Q17).
- The Consumer Price Index (headline CPI) rose to a six-year high of 2.8% year-on-year in May.
- The Fed raised its policy rate during the quarter by a single 25 bps hike at its June meeting, and signaled two more hikes to follow over the second half of 2018.
- Incoming data for consumer spending, exports, and business investment suggest that GDP growth may exceed 3% in the second quarter.
- The escalation of trade tensions in recent months represents a growing risk to the “synchronized” global economic expansion, and pressures are likely to increase before either side offers concessions.
- Despite continued strong fundamentals, we continue to advocate for investors to be cautious in the face of a global economic cycle in the late stages of expansion.
U.S. Economy Grew at 2% Pace in Q1, but Expectations Higher for Q2
The U.S. economy grew at a more muted pace in the first quarter of 2.0% q/q annualized following a 2.9% growth rate in 4Q17. Growth in the first quarter was sapped by weaker personal consumption growth of just 0.9% q/q annualized, while business investment remained strong (+10.4% q/q annualized).
In the second quarter, personal consumption appears to have rebounded considerably. Retail sales for the so-called control group of goods and services rose at a 5% pace over the last three months through May, up from just 2.1% in March.
Meanwhile, the Institute for Supply Management (ISM) surveys of both manufacturing and services business activity rebounded from 2018 lows in April to near cycle-high levels of 60.2 and 59.1, respectively, in June. Broad-based strength across a range of indicators has led to a number of forecasters calling for Q2 GDP growth of 3%-3.5%. The Atlanta Fed’s GDPNow estimate for Q2 growth stood at 3.8% as of 7/6/18.
Inflation, Hot Job Market Push Fed to Add 4th Hike to 2018 Forecast
The pace of inflation picked up during the quarter across most measures. Headline CPI rose to a six-year high of 2.8% in May, though the move partly reflected “base effects” of weak readings from early 2017 rolling out of the annual figures. Core inflation measures, which strip out the volatile food and energy components, also rose during the quarter. Notably, the Fed's preferred inflation gauge, the Personal Consumption Expenditures Core Price Index (Core PCE), reached the Fed's target level of 2.0% in May.
Job creation re-accelerated in the second quarter as employers added an average of 211,000 jobs per month over the quarter. The unemployment rate fell to a 48-year low of 3.8% in May before rising back to 4.0% in June. Wage growth remained solid, though perhaps somewhat muted relative to the continued robust pace of hiring. Average hourly earnings rose 2.7% y/y in June and the Atlanta Fed’s Wage Growth Tracker showed median wage growth advanced at a 3.2% pace (q/q annualized) in May.
The Fed raised its policy rate during the quarter via a single 25 bps hike at its June meeting, as widely expected. Consistent with the Yellen-now-Powell Fed’s gradualist, data-driven approach to policy decisions, policymakers reacted to the stronger incoming data by raising their forecast for the pace of hikes in 2018 to include a fourth hike. The median of FOMC members’ official projections still calls for a high-water mark for the Fed Funds rate of 3.4% by the end of 2020.
Escalating Trade Tensions Rattle Global Financial Markets
Trade tensions between the U.S. and China escalated during the quarter. The U.S. moved ahead with a first round of tariffs on imports from China ($50 billion) and announced the potential for up to $400 billion in further tariffs if China retaliates with its own tariffs. Indeed, China has publicly vowed an equal response to all U.S. tariffs. With its renewed threats to exit NAFTA, the implementation of steel and aluminum tariffs and calls for tariffs on $250 billion of auto imports, the administration also took steps during the quarter to broaden the trade dispute beyond China to include other major trading partners like the EU, Canada, and Mexico.
Volatility in global financial markets rose during the quarter as investors struggled to assess the potential impacts of a trade war on global growth. Chinese stocks fell 13% in U.S. dollar terms over Q2 while a number of emerging markets saw similar declines in both equity and currency markets. U.S. stocks outperformed global developed markets during the quarter and the U.S. dollar rallied almost 5% on a trade-weighted basis. Developed market equity returns remained positive on the quarter, however, suggesting that investors don’t view the current trade dispute as likely to sink the global expansion, at least for now.
Incoming data for the U.S. economy suggests that consumer spending bounced back in the current quarter and business investment remained robust. This combination may produce a “goldilocks” growth quarter in Q2, with some economists calling for GDP growth of 3%-3.5%, or even 4%. However, with the Fed in gradual – but persistent – tightening mode, tighter monetary policy should eventually start to take the steam out of the expansion. As such, the next few quarters of growth could be “as good as it gets” for the U.S. economy this cycle.
1. Source: St. Louis Federal Reserve FRED database, Bureau of Economic Analysis, Institute for Supply Management, 2Q18 GDP estimate via Federal Reserve Bank of Atlanta’s GDPNow as of 7/6/18
2. Source: Thompson Reuters, U.S. Commerce Dept., Capital Economics, Goldman Sachs Economics
The information contained herein reflects the views of Galliard Capital Management, Inc. and sources believed to be reliable by Galliard as of the date of publication. No representation or warranty is made concerning the accuracy of any data and there is no guarantee that any projection, opinion, or forecast herein will be realized. The views expressed may change at any time subsequent to the date of publication. This publication is for information purposes only; it is not investment advice or a recommendation for a particular security strategy or investment product. Graphs and tables are for illustrative purposes only. FOR INSTITUTIONAL INVESTOR USE ONLY. © Copyright Galliard Capital Management, Inc. 2018 All rights reserved. ECON07122018