ECONOMIC UPDATE


  • Q1 GDP exceeded expectations despite weaker personal consumption
  • Core inflation and wage growth has accelerated recently, particularly on a year-over-year basis
  • Fiscal and political headlines continue to weigh on risk markets, and an escalation of trade tensions would have greater long-term economic implications

The economy expanded at a faster-than-expected pace in the first quarter, with the first estimate of Q1 GDP growth at 2.3% (2.0% expected). While growth exceeded expectations, it was the weakest quarter-over-quarter rate since Q1 2017, but the underlying details were encouraging to an extent. The upside surprise for top-line growth occurred despite the smallest contribution from personal consumption since Q2 2013, which was largely attributable to weaker growth in auto sales following the post-hurricane surge that occurred in Q4. Inventory building was less robust than some expected, which implies a potential boost in production in the current quarter.

The initial Q1 GDP estimates also showed core PCE rising 2.5% versus the prior quarter (annualized), the fastest pace since 2007, and the separate March report of core PCE released several days later revealed a 1.9% year-over-year increase in core prices (up 30 basis points from February). The March increase was largely expected given the base effect. In other words, a rare negative core PCE reading in March 2017 created a lower comparison point for the 2018 year-over-year comparison, but regardless, core inflation metrics (both PCE and CPI) are now effectively at the Fed’s 2.0% target. Additionally, the Employment Cost Index (ECI) rose 2.7% year-over-year in Q1, the biggest gain of the current expansion phase, and this broader measure of total compensation has been on a steady upswing since 2015 (see Exhibit 1). The combination of hotter core inflation and wage growth should keep the Fed on course for a June rate hike, with strong support from the Phillips Curve enthusiasts of the FOMC.

Beyond the data trend, political and fiscal headlines continue to capture the market’s attention. In recent weeks, the three major areas of focus have been 1) geopolitical concerns (Syria, North Korea, Iran, etc.), 2) a potential trade war, and 3) legal concerns for President Trump. Geopolitical concerns have lessened more recently given progress in North Korean denuclearization discussions, as well as the perception that the military strikes in Syria were an isolated event (and not the start of a prolonged campaign). Tensions and rhetoric have lessoned on the trade front as well, and U.S. and Chinese officials continue to negotiate behind the scenes. However, any signs of failure in negotiations with China will likely spark a negative reaction in risk markets. For the third item, the FBI raid of Michael Cohen’s office and residence initially spooked investors (political stability concerns), but there haven’t been any new revelations on that front. From an economic perspective, the second item carries the biggest potential ramifications over the long term. Trade confrontations can escalate into a full-blown global trade war, which has proven negative for global growth, inflation, and financial asset valuations in previous episodes.

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