Steven Andrew takes a look at the recent US economic growth and reveals a vulnerability in market confidence
If a week is a long time in politics, it’s even longer in financial markets. The past seven days have seen the market jolted out of its complacency on US economic growth and distracted from upward inflation risks only to then have these renewed fears themselves questioned by stronger data at the end of the week.
With month-to-month newsflow so choppy, it is more important than ever to maintain a medium-term perspective on the economy. Lead indicators still tell us that growth momentum continues to fade but should remain close to trend.
There are downside risks but the absence of policy tightening suggests these will remain in the background. So, just as growth optimism should be kept in check, we feel it is equally inappropriate to become overly pessimistic on the outlook.
US confidence intact
Confidence in the resilience of the US economy remained intact throughout the first quarter thanks mostly to comments from Fed chairman Alan Greenspan – who, as well as issuing reassuring words on growth, gave some avuncular advice on the need to be alive to the upside inflation potential in order to coax the
Treasury market into pricing in a bit more risk. This diagnosis was helped by a strong start to the year from consumer spending – albeit assisted by higher than expected (and transitory) tax rebates.
All seemed to be going well until last Friday when what was ultimately second order data – from the New York Fed’s manufacturing survey and the University of Michigan consumer sentiment report – was enough to question the sustainability of robust US growth (though they did follow some disappointing March retail sales figures), provoking a significant market reaction.
As influential as chairman Greenspan is, this serves as a timely reminder that the markets will respond to his reassurances only for as long as they are supported by reality.
For the time being, downside growth fears seem to have been assuaged by a stronger Philly Fed index and diverted by an elevated March CPI report. But this past week revealed a vulnerability in markets confidence and weaker growth signals clearly have the capacity to solicit an over-reaction.
Going forward, the key indicators in terms of our own outlook for the US economy remain the monthly payroll report and the manufacturing ISM. We continue to project an average monthly gain of around 150k in the employment report (last month it was 110k; we predict next month will be higher).
For the ISM, we would expect the steady moderation which has been in place for the past nine months or so to remain, with the April figure (to be released 2 May) slipping to 54.6 from 55.2 in March.
Key developments
Latest UK inflation data was significantly higher than the market had expected, reintroducing fears that the Bank of England would need to respond to signs of upward price pressure by raising interest rates immediately after the General Election. The headline rate of CPI inflation rose to 1.9 per cent year-on-year in March, up from 1.6 per cent in February, reaching its highest level for seven years. The breakdown of the inflation data shows much of the increase to be concentrated in oil and food prices, which can tend to cloud the underlying inflation signals; core inflation is running at 1.5 per cent – the same as it was three months ago. A further uplift was given to the March data by dearer airfares than last year but this is mostly down to the timing of Easter (March this year, April last) and so should unwind next month.
More relevant for the outlook for the economy and interest rates is the health of the consumer. And in that regard the additional costs that are imposed by higher prices, whether they be for petrol, flights or, more significantly, dearer taxes, act as an additional charge against household incomes – which are clearly struggling to sustain the heady rates of consumption growth seen in recent years. And with retail sales growth in March down to just 2.7 per cent year-on-year compared with the 7 per cent rates seen just six months ago, there is no doubt that demand growth is slowing down.
Given the Bank of England’s stated appreciation of the difficulties in properly understanding the link between unemployment and wages in recent years, other information will probably exert greater influence upon the MPC’s near-term rate decision. The minutes of the April MPC policy meeting, published last week, provide support for this view. The voting split maintained the anticipated 7:2 majority in favour of keeping rates at 4.75 per cent, with Paul Tucker and Andrew Large voting for a rate rise for the second month running. But while the vote split was the same, the overall tone of the minutes can probably be considered moderately dovish on the prospects for a May rate increase. The MPC doesn’t rule out a May hike but it does step back from the explicit statements in February and March that, essentially, if things pan out as it expects, rates will need to go higher eventually. Either way, the added fact that the feared downside risks to household consumption were thought of as having “crystallised to some degree,” should be enough to comfort the doves that rates are staying put unless the consumer undergoes some kind of revival.
Steven Andrew is an economist at F&C Asset Management plc
