Growth Remains Moderate – Weather Distorts Data
April 21, 2017
Early in the year it appeared that the economy was in the process of taking off. Three months later it has seemingly slowed dramatically. But monthly data swings are the norm, not the exception. As we see it, the economy continues to chug along at about a 2.0% pace. Expectations were too high earlier and they are too low today. In this case, most of the shifting expectations are attributable to nothing more than the weather which frequently tends to muddy the outlook at this time of the year. Specifically, the warmer than normal weather early in the year boosted everything from employment, to retail sales, to housing starts, and interest rates. Once the weather returned to normal suddenly all of those indicators seemed weak. It is sometimes hard to look past the monthly wiggles and the associated knee-jerk reaction by the markets. But, more often than not, it is the right thing to do. Not to worry, growth remains at a steady – if unimpressive – pace for now with somewhat faster growth likely in the quarters ahead.
In December, January, and February virtually every economic indicator seemed strong. Employment gains surged to about 200 thousand per month. Housing starts climbed 10% or so from 1,150 thousand from 1,275 thousand. Retail sales jumped 1.0% in December and an additional 0.5% in January. The inflation rate climbed by 0.3% in December and another 0.6% in December. With the economy at full employment the fear was that this additional strength would boost the inflation rate far above the Fed’s 2.0% target and force the Fed to raise short-term interest rates more than three times this year. Good news. Bad news. The economy was doing better, but the Fed might have to raise more quickly than expected to cool things off.
The March data provided an entirely different picture. Employment slid to just 98 thousand. Housing starts fell almost 7%. Retail sales declined 0.2%. The inflation rate fell 0.3%. Suddenly expectations shifted. The economy wasn’t expanding too rapidly after all. The inflation rate might not surge. The Fed does not have to panic. It can afford to maintain its go-slow trajectory for raising interest rates.
While perfectly understandable, it is hard not to get caught up in the enthusiasm (or disappointment) of the moment. Which is why we always recommended looking at 3-month averages which smooth out some of the monthly distortions. Longer-term averages, like year-over-year growth — even out the data so much that changes in trend may not be discernible for months. That is not good either.
In this case, the apparent surge and subsequent slowdown were clearly impacted by deviations from normal winter weather patterns. In other recent years we have seen surprisingly harsh winter weather conditions depress the early year data. By spring the weather returned to normal and pent up demand caused sales to surge. This year was the opposite. January and February were much warmer than normal in most areas of the country. Builders were able to dig some holes in the ground and begin construction on a number of new houses and apartments. Consumers took advantage of the mild weather conditions and went shopping for cars and other goodies. Perhaps they bought some garden equipment they might ordinarily have bought a couple of months later. In March when those housing starts and sales would ordinarily have occurred they did not materialize because they had actually taken place a couple of months earlier.
Are those swings in economic activity legitimate? Yes. Do they mean much? No. At some point the weather will return to normal and, in this case, people should have expected the March data to be as weak as the January and February data were strong. But markets are markets and they react to each new data point. But you, dear readers are able (most of the time) to sift through the monthly wiggles and keep your eye on the trend. As we see it, the housing market is steady and builders will gradually boost the pace of production. Consumers are continuing to spend at a moderate rate. Inflation is inching its way higher. And the Fed remains on track for three rate hikes this year which would bring the yearend funds rate to 1.25%.
The economy may deviate from our expectation as the year progresses but, for now at least, the moderate growth scenario remains intact.