Q1 GDP was revised higher, as was March Durable Goods. April data was somewhat lackluster. What does this mean for the economy? Allow me to explain.
The second reading of Q2 2017 U.S. GDP resulted in an upward revision to 1.2% from an initial reading of 0.7%. The Street consensus forecast called for an upward revision to 0.9%. Inflation readings within the GDP data indicate that inflation dipped slightly to 2.2% from 2.3%.
Durable Goods Orders declined 0.7%, but this was less than the Street consensus estimate of -1.5% and the March reading was revised higher to 2.3% from 0.9%. However, ex-transportation (so-called Core Durable Goods) fell 0.4%. This was worse than the Street consensus calling for an increase of 0.4%. The good news was that March Durable Goods Ex-Trans was revised higher to 0.8% from 0.0%.
Capital Goods Orders, a proxy for business spending and investing, was flat in April. The Street has expected a gain of 0.5%. The March reading was revised lower to 0.0% from a prior read of 0.5%. Capital Goods Shipments fell 0.1%. This was down from a downwardly revised 0.2% (down from 0.5%) and below the Street consensus estimate of 0.5%
Let’s break down the data.
That Q1 17 GDP was revised higher does not come as a surprise. Revisions to much Q1 data have been in a positive direction. Commenting late yesterday afternoon to my WS&M colleagues, I opined that I would not be surprised if the upward revision to Q1 GDP exceeded the Street consensus estimate of 0.9%, perhaps printing at 1.0% or 1.1%. The actual revision was 1.2%. However, there are still cracks in the better Q1 data. For instance, part of the revision to consumption spending was due to electricity-usage data for February, which indicated that consumers’ energy bills during the unusually warm weather weren’t as low as thought. Although it adds to GDP, it is not an indication that the economy is gaining momentum. Inflation measures within the GDP data softened, slightly. While the moderation of inflation pressures was minor (statistical noise), there were no signs that price pressures are poised to surge higher. WTI trading below $49, this morning attests to that.
Durable Goods data continues to look consistent with a 2.0%-area economy. The data were mixed. We did see a strong increase to 2.3% for March Durable Goods Orders, but this was due almost entirely to the very volatile commercial aircraft orders. Although the headline Durable Goods Orders, backing out transportation, fell 0.7%, this was better than the Street consensus estimate of -1.5% and the March data was revised higher to 0.8% from 0.0%. Other than that, there were scant signs of economic acceleration in the data.
Most of the data, considering revisions appear consistent with a 2.0%-area, moderate inflation economy. What has some economists concerned is the dearth of capital spending in the economy. Capital Goods Orders contracted and the March data was revised lower. Most economists see this as a sign of a lack of business confidence. I am in partial agreement with this hypothesis. A lack of clarity in tax policy and healthcare may have business spending on hold. However, I also believe technology is having an impact on capital spending
In an industrial economy, capital spending would focus on manufacturing and mining equipment, buildings and transportation (vehicles). In a digital economy, capital spending is often on technology, which tends to experience deflation or disinflation in real and, sometimes, in nominal terms. Tech is also often less expensive to purchase than buildings, manufacturing equipment and vehicles. Still, as computers and electronics orders were down 0.2% in March, it appears that policy uncertainty is mostly to blame for the latest slump in capital spending.
Some economists believe that it was the stronger March and Q1 capital spending that is anomalous. Bloomberg Economists Carl Riccadonna and Yelena Shulyatyeva write:
“Business investment was revised to show an even stronger — and most likely one-off –performance in the quarter, which was dominated by energy-sector investment. The prospects for continued capital investment dimmed moderately by the disappointing outcome for economy-wide corporate profits, which contracted following two quarters of growth. This will serve as a reminder that animal spirits in the private sector may be less ebullient than the enthusiasm reflected in a range of industrial surveys.”
Note: Bloomberg Economists view Q1 business investment as unsustainably strong, as per GDP data, evens Capital Spending data for March was flat.
University of Michigan Confidence data softened, but remains optimistic. The Sentiment Index fell to 97.1 from 97.7. Expectations fell to 87.7 from 88.1. Five to ten year inflation expectations rose to 2.4% from 2.3%.
To summarize the data:
I believe the upward revisions to first-quarter economic data, combined with the economic data misses in Q2 (thus far) are consistent with a 2.0% GDP and 1.8% to 2.2% CPI economy. This is an economy which is sufficiently strong for the Fed to renormalize monetary policy, but not sufficiently strong for the Fed to act aggressively. The yield curve is reflecting this scenario. Sentiment data lead me to believe that consumers remain somewhat too optimistic regarding economic growth and a bit too concerned regarding inflation. My base case is for the final reading of Q1 17 GDP to remain at 1.2% and for Q2 GDP to run in the neighborhood of 3.0%.
The long end of the UST curve is unchanged versus prior to the data, with the price of the 10-year UST note up 6/32s to yield 2.33%. The 2-10 curve is more than a basis point flatter and now sits at 94 basis points. This is the flattest since last October. Although I believe the yield curve will experience a bear flattening over the next year or two (short rates rising more than long rates), much of the flattening I expect to see for 2017 has probably already occurred. Unless there is a geopolitical event, or we see surprises on the fiscal and/or monetary policy fronts, 2017 could be a fairly boring year from here on out. Benchmark yields could remain relatively low and risk asset valuations fairly bloated.
About Thomas Byrne
Thomas Byrne has achieved a 26-year career in financial services, 23 of which have been spent in the fixed income market sector. In his role as Director of Fixed Income for Wealth Strategies & Management LLC., Byrne is responsible for providing strategic analysis and portfolio management to private clients and institutions, in addition to offering strategic advisory services to other financial services organizations. Byrne's areas of expertise include trading preferred stock, corporate bonds, mortgage backed securities, government debt, international debt, and convertible bonds. Additionally, Byrne provides analysis, strategy, and commentary within the fixed income market. Prior to joining WS&M, Byrne worked as Director in the Taxable Fixed Income Department of Citigroup, Inc., in addition to predecessor companies in New York, NY.