The Conference Board Leading Economic Index® (LEI) for the U.S. increased 0.6 percent in February, following a 0.6 percent increase in January, and a revised 0.6 percent increase in December. Over the past six months, the LEI for the United States has increased 2.3 percent (or about an annualized rate of 4.6 percent), much faster than the previous six months total growth of 0.8 percent.
In the most recent report, nine of the ten components expanded, with only housing starts slightly contracting. This is significant because the LEI is generally considered one of the best predictors of economic growth over the next 6 months. Also, this helps to explain why the Fed has decided to move up rate increases and while we earlier thought the Fed would resume rate increases in June, they increased rates in March and now we expect another increase in June.
The positive contributors to LEI, beginning with the largest contributor, were the ISM® new orders index, the interest rate spread, average weekly initial claims for unemployment, stock prices, average consumer expectations for business conditions, average weekly manufacturing hours , the Leading Credit Index, manufacturers’ new orders for consumer goods and materials, and manufacturers’ new orders for non-defense capital goods (excluding aircrafts); and the only negative contributor was housing starts.
Overall, this is good news for the economy. While we still anticipate annual Gross Domestic Product (GDP) growth of 2.3% in 2017, the economic expansion may pick up moderately.
One reason for the increased pace in interest rates is that rising interest rates lead to increased profits in some sectors (i.e. financials), while increasing costs for those who borrow (contribute to inflation). Similarly, increasing rates helps to cool economic activity and reduce employment opportunities, but for those able to pass on higher interest rates, it creates the opportunity to create higher paying jobs and higher inflation. Counterintuitively, while raising rates moderate the growth of the economy, additional interest rate hikes are required to control what the Fed has started.
Back to specifics in the economy:
GDP: Activity data for January and February suggest the economy got off to a slow start for the year. Our calculations suggest that first-quarter GDP growth will be a modest 2%, perhaps even below 2%. Unseasonably warm weather reduced winter demand for utilities and motor vehicle sales fell back from a 17-year high. However, more recent activity surveys strongly suggest that GDP growth will rebound in the second quarter. Even if the fiscal stimulus is delayed until next year or beyond, we still expect GDP growth to be 2.3% this year.
- Personal Income: Personal income increased by a solid 0.4% month-over-month from January to February, or 0.2% in real terms. Along with the strength of consumer confidence, that’s another reason to expect consumption growth to rebound soon.
- Consumer Confidence: The recent surge in Consumer Confidence by the Conference Board to a 16-year high of 125.6, may on the surface be positive, but it also gives pause to reviewing history. The all-time high for consumer confidence was reached in January 2000 at 144.7. The more recent all-time high of 111.9 was reached in July of 2007. While we don’t have in play the high valuations that occurred at the turn of the century or the financial institution weakness of the most recent crisis, it is important to note consumer confidence has not proven to be the best indicator of financial growth and so we rely more heavily on other factors.
- US Consumption: The modest 0.1% month-to-month increase in personal consumption from January to February equated to a 0.1% month-to-month decline in real terms. The decline in real consumption in February was partly due to another weather-related decline in utilities output, which fell by a cumulative 12.9% between December and February. That decline, which reflects the record warm winter weather in the Northeast that depressed heating demand, will be largely reversed in March, when the weather returns to seasonal norms.
- Inflation: The core PCE deflator increased by 0.2% from January to February, which left the annual core PCE inflation rate unchanged at 1.8%. This is within touching distance of the Fed’s inflation target of 2%. In fact, the annual headline inflation rate jumped to 2.1% last month from 1.9%.
In closing, even though 1st quarter GDP is likely to be lower than expected, much of this is explainable due to warmer weather and lower winter energy consumptions, factors that are set to reverse in the months ahead. In addition, Fed Chair, Janet Yellen, has already said that she would be prepared to “look-through” one quarter of weaker GDP growth and this would allow her to use other “hard data,” like payroll employment and manufacturing output, in determining if the economy is doing fine. Moreover, with inflation picking up, it is likely we’ll see more rate hikes before the Fed takes a seat on the sideline.
Senior Vice President
VisionQuest Wealth Management