HIGHLIGHTS OF THE WEEK
- The BEA’s third estimate of Q1 real GDP downgraded growth slightly to 2.0%, from 2.2% previously. May data did show flat real personal spending, but strength in March and April still set Q2 consumption up for a decent rebound.
- The Fed’s preferred measure of inflation, core PCE, hit its 2% target in May. This supports our forecast for continued gradual monetary policy tightening, as the focus shifts to containing upside risks.
- Shifting headlines on trade were a key driver of stock market activity. Foreign policy also got in on the action, with crude prices surging on the anticipation of tougher U.S. sanctions on Iran.
The U.S. economy slowed more than previously believed in the first quarter of 2018, with growth coming in at 2% ann. according to the BEA’s third estimate, down 0.2 percentage points from the second estimate. The downward revision was largely due to weaker consumer spending, while softer inventory investment also played a part. New data out this morning on personal income and outlays reinforce the notion that the soft start to the year was temporary. Supported by a healthy 0.4% m/m gain in nominal personal incomes, nominal spending rose a respectable 0.2% in May. But given inflation, consumption was flat in real terms. Strength in March and April still set Q2 consumer spending – currently tracking just shy of 3%, slightly below our forecast (Chart 1) – up for a rebound. We continue to expect the economy to grow by some 4% in Q2 given widespread strength in other components.
Consumer spending should continue to follow a decent 2.5% growth path in the second half of 2018, bolstered by a tight labor market and tax cuts, which will continue to support incomes. The latter will feature favorably for housing demand, even as interest rates rise. But a lack of inventory will constrict the sales pace. On this front, pending home sales – a solid gauge of near-term activity – retreated in May, marking the second consecutive monthly decline and weakening a previously improving trend.
Perhaps the most striking element from this morning’s report was inflation data. The headline PCE index ticked higher to 2.3% y/y, while core PCE (the Fed’s preferred measure of inflation) hit the bullseye of 2% for the first time in six years (Chart 2). These developments support our view for the Fed to continue raising rates gradually, with two more hikes expected for 2018. The focus now shifts from below-target-inflation to containing the upside risks.
With little else in the way of primary data, shifting headlines on trade remained an important driver of stock market activity. Markets opened lower on Monday after indications that the U.S. planned new curbs on Chinese investment in U.S. tech firms. Foreign policy also got in on the action, with crude prices surging on the anticipation of tougher U.S. sanctions on Iran. The rollercoaster ride in equities continued, with the President seemingly taking a softer stance on Chinese tech investment, but then hinting at the possibility of protectionist action on autos.
Ultimately, trade spats with a number of important trading partners risks siphoning away much of the economic boost from fiscal stimulus by way of higher consumer prices, reduced exports, supply chain disruptions, and by denting consumer and business confidence. Under the presumption that the tougher trade rhetoric is simply a negotiating tactic, there is still hope that common sense will prevail, and tensions will de-escalate. The risk, however, is that once the wheels have been set in motion, tensions can quickly escalate to a full-out trade war. China, Mexico and the EU have already retaliated to some degree, while Canada is announcing a detailed list of U.S. products to be slapped with retaliatory tariffs at the time of writing, which will take effect over the weekend. The U.S. may up the ante, further reinforcing the negative feedback loop.
Admir Kolaj, Economist | 416-944-6318
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