HIGHLIGHTS OF THE WEEK
- The American economy grew by 3.2% in the first quarter of 2019, comfortably beating market expectations. However, the strength was driven by inventories and net exports, while domestic demand growth weakened.
- The housing market continues to be an economic weak link. Existing home sales in March fell below expectations. A lack of inventory appears to be weighing on sales activity.
- As confirmed in the GDP report, price pressures were softer than expected early in the year, underpinning the Federal Reserve’s move to the sidelines.
U.S. – Q1 Growth Surge Shakier Underneath The Hood
The The U.S. economy brushed off disruptions caused by the partial government shutdown and abnormal weather, and grew strongly in the first quarter, beating consensus expectations by 0.9 percentage points (3.2% vs 2.3%). However, behind the sheen of the solid headline, the drivers of growth were not as lustrous. Domestic demand growth weakened, with consumers saving a little more and businesses slightly more cautious with their investments dollars. Instead, inventories and net exports – the more volatile components of GDP –provided the heavy lifting. The build-up of inventories is now a three quarter trend. It is likely to be reversed in the quarters ahead, dragging on real GDP growth. The good news is that with temporary disruptions dissipating, domestic demand should improve next quarter, taking the mantle in driving growth.
Amid the hurrah of strong real GDP growth, the one segment of the economy that continued to underperform was housing. Residential investment contracted in all four quarters of 2018, and pulled back again in the first quarter. Early indications suggest a mixed start to the second quarter. Existing home sales fell 4.9% in March, below consensus expectations. The pullback followed a strong gain in February, but the level of sales has shown little overall progress over the past several months (and is well off peak levels seen in the fall of 2017). Fortunately, the news was better on the new home sales front. New single-family residential sales rose 4.5%, building on even stronger gains in January and February. In contrast to the existing market, new home sales are just a touch below the recent cycle peak.
With affordability improving – a function of both lower mortgage rates and accelerating income growth – the demand drivers for housing appears to be solid. The supply side appears to be the constraining factor. The inventory of existing homes available for sale continues to hover near historical lows. Unless supply constraints are alleviated, the upswing in demand could reverse the recent deceleration home price growth.
Speaking of prices, PCE inflation data for 19Q1 was released alongside GDP data and came in surprisingly soft. We cannot yet tell which month the weakness was concentrated as only January data are available (February and March data will only be released on Monday). Nevertheless, the weaker reading in Q1 indicates cooling price pressures, reinforcing the Federal Reserve’s position to hold off any interest rate hikes through 2019. Bond yields appear to have dipped lower following the digestion of these details, discounting the surprise in real GDP growth.
Headline inflation is likely to see something of a lift in upcoming months, reflecting the broad-based rebound in oil prices since the end of 2018. Still, the ride may be bumpy. The West Texas Intermediate oil price benchmark hit $65 earlier in the week, before falling on Friday on word that Trump has been upping the pressure on OPEC. This, despite news that the administration will no longer exempt countries from Iran sanctions beginning May 2nd.
Sri Thanabalasingam, Economist | 416-413-3117
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