HIGHLIGHTS OF THE WEEK

  • Following the failure to repeal and replace the ACA, market participants questioned the new administration’s ability to move forward with pro-growth policies. As such, major indicators opened lower on Monday, but risk sentiment recovered quickly as the week progressed.
  • Positive developments included pending home sales data and an upward revision to fourth quarter GDP growth. Conversely, new data pointed to a deceleration for real consumer spending growth to below 1% (annualized) this quarter. That said, this appears to be only a temporary setback.
  • Much of the recent sentiment uptick is related to the anticipated implementation of pro-growth policies. There are certainly risks on this front, suggesting that the Fed’s ‘wait and see’ approach is the right one as far as baking in any potential impact on the economy.

 

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MARKETS OVERLOOKING POLITICAL SETBACKS

The failure of the bill to repeal and replace the ACA last Friday set the tone for investors at the start of this week. Market participants questioned the new administration’s ability to build consensus and move forward pro-growth policies, with major U.S. stock indices along with the greenback and long-term government rates opening lower on Monday. But, risk sentiment recovered as the week progressed, with most aforementioned indicators recovering beyond last Friday’s levels (Chart 1). This was despite the triggering of Article 50 – the official initiation of the long divorce proceedings between the U.K. and E.U. – which has been largely anticipated. The recovery was partly related to the quick pivot by the U.S. administration to other agendas, such as tax reform, with emphasis on bringing forward the infrastructure plan and some executive actions. Moreover, the data-tone also helped ease some of the concerns.

The week was relatively light as far as first-tier economic data goes. But secondary indicators, such as pending home sales looked promising, surging in February and bringing the index level to a 10-month high. Unseasonably clement weather was part of the story, with some giveback likely in March. Nonetheless, this is a welcome development as it reinforces the notion that despite rising interest rates, housing continues to contribute to economic activity given solid labor market fundamentals.

Another positive development was the upward revision to fourth quarter GDP growth. The economy expanded by 2.1% (previously reported as 1.9%) due to more strength in consumer spending – upgraded by half-point to 3.5%. After that knock-out quarter, consumers tightened their purse strings at the start of this year. Data out this morning showed that real spending fell for a second consecutive month in February, with weather and delayed tax rebates likely playing a part. As such, real consumer spending looks set to advance by less than 1% in the first quarter of 2017. Still, this is likely to be only a temporary setback. Spending should bounce back in the second quarter, thanks to strong consumer confidence and accelerating income growth, restoring economic growth to a well-above trend rate.

While the economy remains on solid footing there has been an increasing divergence between survey and sentiment metrics (soft data) and harder indicators of economic activity (i.e. sales and incomes). This narrative can be illustrated by Bloomberg’s surprise index where hard data has come in largely as expected while survey-based data has been the main thrust behind an improvement in the measure (Chart 2).   

Ultimately, the strength of the economy will depend on which way the convergence will occur. Much of the sentiment uptick is related to the anticipated implementation of pro-growth policies. However, doubts as to the probability of success could quickly manifest into weaker readings. There are certainly risks on this front. For starters, tax reform is complex, and while lawmakers have some leeway, delays could put a dent in sentiment. Additionally, the failure to repeal and replace the ACA leaves the budget plan billions short, increasing the likelihood of scaled-down versions of other parts of the agenda. All told, it would appear the Fed’s ‘wait and see’ approach is the right one as far as baking in any potential impact on the economy, with the anticipated three hike per year pace seemingly appropriate for the time being.

Admir Kolaj, Economist

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