Key Takeaway: We don’t want to be trite by offering a token golf clap to the U.S. economy bulls in response to the strong JAN PCE data and positive revision to Q4 GDP. It’s more appropriate to offer a standing ovation instead. But what happens after standing ovations? Hint: the audience sits back down... All told, our views on the likely progression of the domestic economic and financial market cycles remain unchanged (see section #3 below for more details).
Section I: January Personal Income & Spending Recap
Both income and spending accelerated to start 2016 as the combination of accelerating aggregate wage income and a small decline in the savings rate, off of multi-year highs, combined to drive sequential improvement in household spending. The January NFP data signaled as much (see: yesterday’s Early Look: Number 2 for details) so we got largely what we were expecting with the official release this morning.
An annotated visual tour of the underlying data is below but here are a few key points:
- The January data was solid but the Trend remains one of deceleration. Income growth, employment growth, consumption growth, consumer confidence and corporate profits all peaked in 4Q14/1Q15 and have been slowing since. Income growth drives the capacity for consumption growth and with weekly hours flat and employment growth slowing, we’ll need to see an ongoing acceleration in wage inflation to maintain the pace of aggregate income growth near current levels. Unless one believes wages will accelerate towards +3.5% in fairly short order, the Trend slope of aggregate income growth (and consumption growth by extension) should remain negative.
- Core PCE marked its 45th month below target in January but accelerated for a 3rd consecutive month to +1.67% YoY. From a policy perspective, the gain bolsters the argument for continued interest rate normalization. It also, however, bolsters the risk that further policy divergence out of the Fed serves to perpetuate the deflationary and growth slowing trends that have characterized most of the last eight months. The probability that positive seasonality and easy comps optically boost reported fundamentals in 1Q (see: Early Look: Optical Mischief) also raises the risk of a potential policy blunder.
- The dynamics underlying the rise in inflation are also not inconsequential. The benefit of lower energy prices for consumers is being absorbed by higher savings and services consumption (which is why it hasn’t really shown up in the Retail Sales data). Inside of services consumption, much if it is going towards housing (rent/housing inflation is running at a wide premium to income growth & broader price trends) and healthcare consumption. The rise in healthcare consumption is largely attributable to Obamacare and the influx of newly-insured seeking care. Rising housing costs, while supportive of the Fed’s inflation target, largely represent excess growth in a key consumer cost center and a drag on other discretionary and housing related consumption. Rising inflation driven by disproportionate growth in major consumer cost lines is different than demand-pull inflation driven by (persistent) wage inflation and rising discretionary consumption.
-Christian Drake, Senior U.S. Macro Analyst
Section II: Q4 GDP Revision Recap
The headline number beat on flimsy-at-best internals:
- Consumption was revised down by a small amount.
- Net Exports were revised up as the negative revision to Imports outpaced the negative revision to Exports. That setup is good from a GDP accounting perspective but lower Import and Export activity calls attention to waning aggregate demand trends – both domestically and externally.
- Almost all of the +30bps revision to the headline growth figure was due to the positive revision to Inventories, which was revised higher by 31bps.
-Christian Drake, Senior U.S. Macro Analyst
Section III: Revising Our Outlook for U.S. Economic Growth
With the advent of this 1-2 punch of generally positive economic data, we are revising up our outlook for domestic economic growth:
- Our GIP Model has U.S. Real GDP growth tracking at +2.0% YoY in 1Q16. This figure represents a +20bps revision to our previous forecast. This moves us ever-so-slightly into #Quad2, which is what had been and still is being implied by the comparative base effect for Q1. Our initial #Quad3 forecast was a function of extrapolating the trending deterioration in growth momentum into the first quarter, but that looks to be less appropriate with the advent of some JAN data including this morning’s Real PCE print.
- The aforementioned +2.0% YoY growth rate translates to +1.0% on a QoQ SAAR basis. This figure represents a +40bps revision to our previous forecast. For comparison’s sake, the Atlanta Fed’s forecast for Q1 was just revised down to +2.1%. We expect their model to continue heading towards our [much-lower] estimate as the quarter progresses. Refer to the 2nd half of our 2/17 note titled, “What’s More Important: the Short Squeeze in the Market or the Data?” for details on why.
- On a full-year basis, we now see U.S. Real GDP coming in at +1.4%, which is up small from a previous estimate of +1.3%. This would still mark the slowest annual growth rate since 2009. Our 2016 GDP estimate implies Nominal GDP growth of +2.8%, which would also represent the slowest rate of annual change since 2009. Please note this as a meaningful headwind to the current Bloomberg consensus forecast of 119.58 for S&P 500 NTM EPS.
Moving along, the conspiracy theorist in me doesn’t want to believe the strength in this morning’s JAN Real PCE data. Having consumed enough @Zerohedge tweets about seasonal-adjustment shenanigans over the past two weeks, I came away somewhat surprised to learn of no holes in today’s print. This was a good number and represents a healthier U.S. consumer than we anticipated when we published, “50 Charts On Why Consensus Macro Is Dead Wrong On the U.S. Consumer” back on January 19th.
In fact, further analysis would seem to suggest that U.S. economy bears such as ourselves were perhaps reading too much into the SA vs. NSA debate that’s emerged in recent weeks with the advent of the Retail Sales, Durable Goods and Capital Goods releases for the month of January. Specifically, the Z-Scores for the basis point spread between the SA and NSA YoY growth rates for each reading were 1.6, 0.7 and 1.0, respectively; each is on the high side of historical readings, but not high enough to suggest a not-yet-reported material leg down in the underlying health of the U.S. economy.
So what does this all mean for markets? We believe the three most important takeaways are as follows:
- Growth is still slowing on a trending basis across a variety of key high-frequency indicators. And outside of personal consumption data, the preponderance of indicators that are showing sequential and/or trending accelerations in recorded growth rates are still contracting from a YoY perspective and remain sensitive to incremental commodity price deflation from here.
- On an inline-or-better FEB Jobs Report next Friday, the Federal Reserve may read into the positive JAN PCE report – specifically the Core PCE Deflator within – and/or Q4 GDP as justification for another rate hike at its 3/16 meeting. At +4bps and +7bps DoD, respectively, both 1Y OIS spreads and 2Y Treasury note yields support this conclusion, on the margin. The implied probability of a rate hike at the FOMC’s 3/16 and 4/27 meetings are up +200bps (to 12%) and +540bps (to 20.8%), respectively, on the day. It goes without saying that incremental tightening of domestic (and global) financial conditions from here remains a key risk to asset markets.
- As highlighted in our 2/24 Early Look titled, “Relatively Insignificant”, the probability of a U.S. recession over the next 2-3 quarters continues to rise on a trending basis. Additionally, both the credit and corporate profit cycles continue to have extremely dour implications for asset markets on a forward-looking basis from here. As such, investors would do well not to read too much into January’s solid Real PCE print.
All told, we were wrong on the pace of economic degradation thus far in 2016 and hope you appreciate our objectivity and intellectual honesty here. We aren’t perma-bears insomuch as we aren’t perma-bulls. We have no horse in this race other than preserving our analytical reputations.
We simply want to be continue being right on forecasting the data and financial market returns from a trending perspective and our intermediate-term TREND calls on both remain unchanged.
-Darius Dale, Senior Global Macro Analyst