HIGHLIGHTS OF THE WEEK

  • First quarter GDP growth came in at just 0.7% (annualized) – slightly weaker than consensus. The main culprit behind the slowdown was consumer spending, which barely grew. Much of the drag on growth appears to be temporary and we expect activity to rebound above 3% in the second quarter.
  • The U.S. administration brought tax reform back into the limelight by releasing a revised one-page blueprint. An emphasis on tax cuts, coupled with a sigh of relief stemming from the French presidential election results, revived appetite for risk assets and helped lift major U.S. stock indices.
  • The possibility of a government shutdown remains a near-term risk. Should it take place, the impact would likely not be enough to derail the economy, provided the shutdown is not prolonged.

 

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FIRST QUARTER GROWTH SOFT, ACTIVITY EXPECTED TO REBOUND

The week was light on primary data releases, with the advance estimate of first-quarter GDP dominating headlines. Growth was anticipated to be soft, and came in at just 0.7% (annualized). This is on par with our estimate, but slightly weaker than consensus and marks another year of soft first-quarter growth. The main culprit behind the slowdown was consumer spending, which barely grew (in what is becoming something of a pattern) (Chart 1). Not all was bad news however, as non-residential business investment growth accelerated, with the pickup led by a boom in spending on structures. As was the case in prior years, much of the drag to growth appears temporary, and we expect activity to rebound above 3% in the second quarter. Looking past the quarterly swings in GDP, we anticipate growth in the U.S. economy to run slightly above 2% – a rate still strong enough to generate a pickup in inflation (see report).

Second tier economic data came in somewhat mixed, with a surge in new home sales, acceleration in employee compensation, resilient pending home sales, and some pullback in consumer confidence. Still, investor attention was primarily focused on political events. The U.S. administration brought tax reform back into the limelight by releasing a revised one-page blueprint. An emphasis on tax cuts, coupled with a sigh of relief stemming from the French presidential election results, where pro-EU candidate Macron took the lead in the first round, revived appetite for risk assets. This helped lift major US stock indices, while lowering prices for safe-haven assets such as gold (Chart 2).

The updated tax blueprint is broadly similar to its prior version. Differences include tweaks to individual tax rates and support for a territorial tax system where foreign earnings are exempt from U.S. tax. The absence of a destination-based cash flow tax, supported by the House Republicans, was also notable. The lack of detail makes it challenging to place a price tag on the plan, but one estimate pegs costs at between $3 and $7 trillion over the next decade. The plan is said to ‘pay for itself’, but broad consensus suggests otherwise, and without offsetting cuts the proposed changes are likely to bloat the deficit.

Politics continued to capture headlines as President Trump put Canada at the receiving end of his trade rhetoric, focusing on trade irritants between the two countries, including dairy and lumber. Talk was followed by action, as the Dep. of Commerce announced its intention to impose preliminary countervailing duties on Canadian softwood lumber. The move is likely to result in higher prices for wood products, feeding through to higher renovating costs and new home prices (see report).

All things considered, the aforementioned developments are unlikely to sway the Fed’s decision at next week’s FOMC meeting, with the Fed unlikely to resume its hiking cycle until June. The possibility of a government shutdown remains a near-term risk, even as steps taken today will extend funding by one week. Even if it does occur, the impact will not derail the economy provided it is not prolonged. Drawing on the 2013 experience, a two week impasse would likely shave off 0.3 pp from quarterly annualized growth. Still, these effects could become amplified should the ongoing uncertainty spill over into private sector spending and investment decisions.

Admir Kolaj, Economist

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