Economic Commentaries

18

Real GDP growth was about 1% annually in the first quarter while inflation was about 1% as well. This is well below consensus forecasts at the start of the year and it can be attributed in part to harsh winter weather. Activity declined in January and February but as the weather normalized in March there was improvement.

The pick-up was most noteworthy in the labor market report for March which showed a steady rise in payrolls and a healthy rebound in hours worked. Also according to the ISM, production rebounded in March. But this is not to suggest that weather was the only restraint on business activity. Indeed, the March rebound merely brought activity back to the norm of the last six months with no indication of the acceleration that has been widely expected. And because GDP growth was much weaker than hours worked in the first quarter, productivity slumped. (This may be an aberration but it bears watching).

We continue to believe more fundamental constraints are in play. Mortgage demand remains weak from a combination of reduced affordability and tough loan standards. Vehicle demand, while strong in March, has been flat over the last nine months despite increased price discounting. Vehicle loans get longer and longer, indicating that sellers are reaching down the affordability ladder to find buyers. A positive is that the household saving rate is neutral. But income growth remains weak amidst stagnant wage growth; cash flows are being crimped by a collapse in mortgage refinancing; prices for necessities are rising and home price inflation is easing. Finally, there is capital investment, which was supposed to be a source of strength this year. But as yet there is no such indication as policy uncertainties prevail and business revenue growth remains elusive.

Momentum outside the U.S. appears lacking as well. Japan raised its sales tax on April fool’s day and business sentiment according to the Tankan survey tanked. The euro zone is maintaining a modest recovery but the triple whammy of a strong currency, approaching deflation, and weakness in Asia is worrisome. So far the Central Bank does not seem too worried which is itself worrisome. Finally, there is China. The economy is slowing; news reports are discouraging; but no one knows by how much. To us the upshot is that even the IMF has lowered its global growth forecast, albeit not by enough in our view.

From all this we continue to believe, Federal Reserve forecasts to the contrary, that the global economy still needs monetary and fiscal help. Targeted fiscal stimulus seems forthcoming in China but in limited doses. Monetary stimulus is also likely as it is in both Japan and Europe. The sooner the better from our vantage point. The Federal Reserve still seems hell bent on extricating itself from asset purchases. But if the springtime rebound fails to meet expectations, we think the Fed will officially taper its economic forecast by June or July. At that point the asset taper may be tapered as well while promising zero short term rates “forever”. In this environment we continue to think long term rates will hover between 2.5% and 3% with a greater probability that the low end of this range is breached.

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