While expectations for a solid first-quarter GDP report are running high, the most recent data flow has been somewhat sloppy. Sloppy enough that it should raise red flags for monetary policymakers pushing to end QE by the end of this year. In addition to the weak employment report for March, the ISM manufacturing index retreated:
In contrast, the industrial production report appeared to signal ongoing strength:
But the details suggest a loss of momentum in March aside from a temporary boost from utilities:
Manufacturing output edged down 0.1 percent in March after having risen 0.9 percent in February; the index advanced at an annual rate of 5.3 percent in the first quarter. Production at mines decreased 0.2 percent in March and edged down in the first quarter. In March, the output of utilities jumped 5.3 percent, as unusually cold weather drove up heating demand.
More disconcerting was the retail sales report, which signaled that the recent strength in consumer spending is waning:
Indeed, this is not terribly unexpected as it likely reflects the impact of higher tax this year. But it is a signal that one should be cautious before extrapolating Q1 GDP numbers. On a more positive note, housing starts were higher, with much of the improvement stemming from multifamily construction:
The solid improvement in housing starts seems at odds with waning builder confidence, but that may have more to do with supply constraints than demand. From the news release:
'Many builders are expressing frustration over being unable to respond to the rising demand for new homes due to difficulties in obtaining construction credit, overly restrictive mortgage lending rules and construction costs that are increasing at a faster pace than appraised values,' said Rick Judson, National Association of Home Builders (NAHB) chairman and a homebuilder from Charlotte, N.C. 'While sales conditions are generally improving, these challenges are holding back new building and job creation.'
'Supply chains for building materials, developed lots and skilled workers will take some time to re-establish themselves following the recession, and in the meantime builders are feeling squeezed by higher costs and limited availability issues,' explained NAHB Chief Economist David Crowe. 'That said, builders' outlook for the next six months has improved due to the low inventory of for-sale homes, rock bottom mortgage rates and rising consumer confidence.'
This suggests the improvement in housing demand is just beginning to have an impact on the overall economy. That impact will accelerate as supply chains rebuild over the next year.
On net, I think the data is telling us a familiar story: The positives in the U.S. economy are difficult to ignore. Housing starts are a very good indicator of the direction of the economy, and that direction appears to be up. But it doesn't pay to get too carried away with any one quarter's worth of data. Underlying growth has been slow and steady since the end of the recession, with positive quarters offset by negative quarters. And the impact of tighter fiscal policy looks likely to produce a similar trend this year. The light at the end of the tunnel, however, is that as the fiscal effect fades toward the end of this year and into next, activity could finally see more of the sustained improvement we have been looking for.
But, at the moment, that sustained improvement looks ephemeral. That is the message of the bond market as yields plunged back to the 1.7% range since the beginning of the year. And the beatdown of commodity prices indicates nervousness on the global outlook as well. If I was a monetary policymaker, I would be paying attention, especially as the inflation numbers are not telling us that imminent tightening is necessary:
Some FOMC members seem to be paying attention to the change in the tone of the data. New York Federal Reserve President William Dudley noted his concerns in a speech today:
In terms of the labor market, we have seen only a moderate improvement in labor market conditions over the past six months or so. After an encouraging pick up in the pace of job creation around the turn of the year, the employment report for March showed a gain of only 88,000 jobs. While I don't want to read too much into a single month’s data, this underscores the need to wait and see how the economy develops before declaring victory prematurely. I'd note that we saw similar slowdowns in job creation in 2011 and 2012 after pickups in the job creation rate and this, along with the large amount of fiscal restraint hitting the economy now, makes me more cautious...
...In the near term, there is considerable uncertainty about the outlook, particularly because the multiplier effects from fiscal drag and sequestration are still unclear. This uncertainty should gradually decline -- for better or for worse -- over the coming months, as the sequester’s impact takes hold and more economic data come in, giving us a clearer picture of the forward momentum of the economy...
... I see the current pace of asset purchases as appropriate.
At some point, I expect that I will see sufficient evidence of improved economic momentum to lead me to favor gradually dialing back the pace of asset purchases. Of course, any subsequent bad news could lead me to favor dialing them back up again.
Notice that he does not suggest, as others do, that it would be appropriate to end quantitative easing by the end of this year. Chicago Federal Reserve President Charles Evans expressed his belief that quantitative easing would stretch into 2014:
Mr. Evans told reporters after a speech in Chicago that he expected 'with a high probability' that bond buying would continue into the fall. He added he 'would not be surprised' if a wind-down carried over into 2014, though offered an upbeat assessment of the economy’s current trajectory and saw no immediate inflation threat.
Prior to the discussion about ending the QE this year, my outlook had been similar to Evans's -- the tapering-off process would begin late this year after the impact of fiscal contraction had passed, with a likely end in the first half of 2014. But recent "Fedspeak" has convinced me that a sizable contingent of policymakers are looking to end QE sooner than later; I suspect that contingent has fallen back to concerns about size of the balance sheet rather than the pace of the recovery.
Bottom Line: The data flow is not as uniformly positive as it seemed just a month ago. Arguably, we are experiencing yet another spring slowdown. This should trigger some monetary policymakers to reassess their predictions that QE could be safely terminated at the end of this year. But there may be a contingent that has dug in its heels on the issue and are asking themselves: "How bad does the data have to get to continue assets purchases?" Rather than: "How good does the data need to be to end asset purchases?" Of course, ultimately the answer will depend on which of these two questions Federal Reserve Chairman Ben Bernanke is asking.