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As the Bureau of Economic Analysis prepares to release its first estimate of first-quarter gross domestic product on Friday, economists are expecting a 2.2% increase compared with 2.2% in the fourth quarter, according to Bloomberg’s economic forecasting consensus.
The Federal Reserve Bank of Atlanta’s GDPNow model-based forecast pegs first-quarter real GDP growth at 2.8%.
Assuming human forecasters are correct, does the down-shift from 2018’s 3% growth rate (fourth-quarter over fourth-quarter basis) represent a soft patch, after which the pace will pick up?
Or has the Federal Reserve perfected its real-time, interest-rate management techniques so as to deliver us unto the Promised Land via a soft landing where growth slows to its potential, prolonging what is soon to be the longest expansion on record?
Or will anemic first-quarter growth offer President Donald Trump an opportunity for a soft-sell approach: A chance to blame the Fed for taking growth down a few notches from his promised 3%-4% pace, and in so doing, tout his management of the U.S. economy?
Let’s look at the various options.
Soft patch
According to economists, first-quarter GDP has been plagued for decades with “residual seasonality,” or factors that depress growth even after adjusting for typical seasonal variations. (For example, retail sales are always stronger in the fourth quarter than the first because of the Christmas holiday.)
According to one estimate, residual seasonality sapped an annualized 0.6% from first-quarter GDP and boosted the second quarter by an annualized 0.5% from 1985 to 2018, even with the BEA’s recent updates to its seasonal adjustment techniques.
This year, first-quarter growth was dampened by the 35-day government shutdown, which affected 800,000 federal employees as well as millions of contract workers and delayed discretionary government spending and tax refunds. Most, but not all, of that foregone spending will be made up in subsequent quarters, according to an estimate by the Congressional Budget Office.
That said, very few economists outside the Trump administration view 3% growth as the new trend. Real GDP growth has averaged 2.3% since the recession ended in June 2009, slightly above its estimated potential of 1.9%.
The U.S. economy’s potential growth rate is being constrained by slow growth in the labor force and in productivity. Unless either input accelerates, what some regard as a “soft patch” looks more and more like the trend.
Soft landing
Central banks are in charge of raising interest rates to slow the economy when it threatens to overheat and of lowering rates to stimulate aggregate demand when growth is teetering.
Unfortunately, their econometric models generally fail to alert them when they have tightened too much. And even if they do, early warning signs, such as an inverted yield curve, are dismissed with an excuse-du-jour as to why “this time is different.”
Only when it is too late does the central bank realize that its contractionary policy has overstayed its welcome, ushering in a recession.
It wasn’t until Sept. 18, 2007, 16 months after the term spread inverted and three months before the onset of the Great Recession, that the Fed lowered the fed funds rate from a cycle peak of 5.25% to 4.75%.
Fifteen months later, the funds rate was at 0%-0.25%.
This time, the Fed looks to have halted its interest-rate and balance-sheet normalization in time to avert a recession. That the stock market had to deliver the message with a 19.8% plunge in Standard and Poors’ 500 Index SPX, +0.05% in the fourth quarter of 2018 doesn’t instill confidence in the Fed’s prognosticating prowess.
Fed Chairman Jerome Powell’s description of monetary policy flip-flopped from being “on auto-pilot” — a reference to the balance-sheet normalization process — on Dec. 19 to “patient” on Jan. 4 to pretty much on hold by March 20, with the majority of policy makers projecting no additional rate increases in 2019.
So has the Fed finally succeeded in delivering the elusive soft landing?
It’s too soon to tell. “A soft landing always precedes a recession,” said Michael Darda, chief economist and market strategist at MKM Partners. “The economy has to slow before it goes into recession.”
Darda pointed to 1995-1996 as “one of the few fabled soft landings.”
After an aggressive tightening campaign that saw the funds rate double from 3% in February 1994 to 6% a year later, real GDP growth slowed sharply in early 1995. The Fed cut rates by 75 basis points in 1995 and 1996.
“The Fed tightens, growth slows, they ease a few times and the business cycle keeps going,” Darda said.
At least that’s how it’s described in the textbooks. Heck, Australia hasn’t had a recession in 27 years!
The term spread, while historically flat, has assumed a slightly positive slope after a brief flirtation with inversion last month. The Fed has abandoned the idea of pre-emptive tightening in favor of a willingness to tolerate inflation that exceeds its 2% target to make up for years of undershooting it.
So for the moment, “soft landing” looks like a reasonable call.
Soft sell
In its 2019 annual report, the White House Council of Economic Advisers projects 3% economic growth for the next decade.
For Trump, anything is possible: 4%, even 6% growth. If it weren’t for the Fed, “the Stock Market would have been up 5000 to 10,000 additional points, and GDP would have been well over 4% instead of 3%,” Trump said in an April 14 tweet.
That real GDP growth slowed from 4.2% in the second quarter of 2018 to 3.4% in the third to 2.2% in the fourth to something close to 2% in the first is not a reflection of the waning effects of the Tax Cuts and Jobs Act but the result of the Fed’s four rate hikes in 2018, according to Trump.
So any first-quarter weakness will provide an opportunity for a soft-sell: a persuasive appeal to the emotions of his supporters that he alone can deliver the goods: more jobs, lower unemployment, a revival of the Midwest’s manufacturing base, better trade deals, strong borders. In short, “the best economy in history.”
First-quarter growth was likely boosted by inventory accumulation. Final domestic demand, which is what matters, is apt to be weaker than the headline number. And today’s economy is nowhere near the best in history. Just look at average GDP growth for any decade prior to 2000 to find stronger growth than in the 2+ years since Trump took up residence in the White House.
A soft sell may convince Trump’s base — not that it needs convincing — but until proven differently, soft landing seems to be the best, or least “soft,” bet.
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