April 17, 2015
First quarter GDP growth is expected to be anemic at 1.4%. Like last year adverse winter weather conditions played a role but other factors are also at work. The slowdown by West Coast dockworkers has negatively impacted both production and consumer spending. The sharp drop in the price of oil has curtailed oil and gas well drilling activity. For some economists the subpar performance in the first quarter has called into question the likelihood of a Fed rate hike in June. We disagree. We expect economic statistics for April and May to provide solid evidence of a second quarter snapback which will make the Fed comfortable with a small midyear increase in rates.
History seems to be on our side. During the past five years first quarter GDP growth has tended to be the weakest quarter of the year which is followed by an impressive rebound during the spring and summer. This year should continue that pattern.
Adverse winter weather conditions have frequently played a role in this first quarter phenomenon. That is true this year as well as record low temperatures appear to have kept consumers inside. Retail sales declined. Housing starts plunged as builders were forced to curtail production. However, mortgage rates remain low, building permits held up well despite the drop-off in starts, and new home sales have surged in recent months despite the weather. To the extent that weather played a role in producing first quarter sluggishness, its impact is certain to be transitory.
The slowdown by West Coast dock workers also played a role as the growing queue of ships at anchor in the harbor waiting to unload meant that manufacturers could not get the parts necessary to maintain the pace of production and retailers were unable to get the merchandise they needed to stimulate sales. But the labor unrest has ended and the backlog will gradually shrink.
Then there is oil. Crude oil prices plunged from $107 per barrel in the middle of last year to about $45.
Not surprisingly the number of oil rigs in service has been cut in half since the end of September, and oil drilling activity has followed suit. While the drop-off is stunning, it is important to recognize that this category represents just 0.7% of all industrial production. Nonetheless, it will create weakness in the non-residential investment spending component of GDP and could subtract 0.8% from first quarter growth.
Unlike the previous two sources of first quarter weakness, this particular category will not rebound in the months ahead. Rather, it should plateau at a lower level in the months ahead and subtract about 0.2% from GDP growth for the year.
While investment spending may get hit by falling oil prices, the consumer is far better off. By spending less to fill the car with gas consumers have more money to spend on other goods and services. Because consumer spending represents nearly two-thirds of GDP the positive impact from a faster pace of consumer spending more than offsets the hit on investment spending. Falling oil prices are a net positive event for the U.S. economy.
How does the Federal Reserve react to these shifting currents? Many economists believe it will postpone the first increase in the funds rate until later in the year. We doubt it. Our expectation is that the economic data for April and May will look sufficiently robust to give the Fed comfort that the first quarter blues will yield to second quarter cheers.
The Fed has indicated that it will not begin to raise rates until such time as the economy has reached full employment. We believe that – by any measure – the unemployment rate will have achieved that level by midyear.
The Fed has also indicated that it does not intend to tighten until it is convinced that inflation is returning to the Fed’s targeted 2.0% pace. That, too, should happen by midyear.
Our sense is that the Fed will not be distracted by another first quarter fizzle. The economy needed 0% interest rates to emerge from its slump, but the economy is no longer on the skids. With nominal GDP consistently chugging along at a 4.0% pace the time for 0% interest rates is long past. Get on with it!
Stephen Slifer
NumberNomics
Charleston, SC
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