Economic and Market Review: First Quarter 2018
The US economy continued on its upward trajectory, with overall growth and employment posting solid gains. The Bureau of Economic Analysis reported its third estimate of fourth quarter 2017 gross domestic product (GDP) of 2.9%, up slightly from the prior estimate, but somewhat lower than the third quarter’s 3.2% reading. The employment situation also made gains, with an average of approximately 242,000 jobs added each month. At the same time, the unemployment rate remained steady at 4.1%. The Federal Open Market Committee (FOMC) modified its interest rate policy by raising the federal funds rate target 25 basis points to a range of 1.50% to 1.75%. Economists expect as many as three additional increases in 2018 as inflation picks up and wage pressures accelerate.
The global economic environment continues to benefit from a rebound in demand and generally accommodative monetary policies. The Eurozone economy grew at a 2.7% annual rate in the fourth quarter, well above trend. Growth in the region has been driven by ultra-accommodative monetary policy, a firming labor market, and robust domestic demand. Japan is expected to maintain its strong momentum into 2018, driven in part by revived external demand. China continued its strong growth from 2017, and experienced its first year-over-year acceleration since 2010. The country’s 6.8% fourth quarter annualized GDP growth was higher than the 6.5% target, even as policymakers are implementing deleveraging designed to limit debt-driven growth. However, economists believe that the focus on deleveraging will inhibit China’s growth somewhat in 2018.
Highlights and Perspectives
GROSS DOMESTIC PRODUCT (GDP)
The Bureau of Economic Analysis released the third estimate of the fourth-quarter 2017 real GDP, a seasonally adjusted annualized rate of 2.9%, down from the third quarter’s 3.2% annualized growth, but up slightly from the 2.5% prior estimate. Economists generally believe it will be difficult to maintain this level of growth while the economy is at full employment, meaning that the expansion may be in its latter stages. Consumer spending continued to drive growth during the quarter. Inflation showed signs of accelerating in the quarter, with the personal consumption expenditures (PCE) index of prices rising 2.7%, following a 1.5% advance in the prior quarter. Corporate profits fell by 0.1% (not annualized) during the quarter. Confidence among businesses and consumers is high, but economists caution that sustaining current levels of growth will be difficult.
The housing segment remains robust, and analysts continue to have a positive outlook for 2018. Existing home sales for February (the latest monthly data available) grew at an annualized rate of 5.5 million units, an increase of about 3% from January, and up about 11% from year-ago levels. The inventory of existing homes was slightly more than three months of supply, down marginally from the prior year. Existing home prices in February were up 0.4% from January, and have increased 5.9% from February 2017. In the new-home segment, the NAHB Housing Market Index, a measure of homebuilding activity, ended the quarter at 70, slightly lower than the previous month. Nevertheless, analysts cite strong homebuilder confidence in maintaining a positive outlook for housing over the coming months.
The employment situation continued to be very robust in February. Employers added 313,000 jobs during the month, far exceeding the consensus expectations of 200,000 new jobs, and outpacing the prior month’s gain of 239,000. The three-month moving average also jumped, coming in at 242,000. The unemployment rate in February remained at 4.1%, unchanged since October 2017. Average hourly earnings increased by a modest 0.1% in the month, with expectations that wages will rise in coming months.
FEDERAL RESERVE POLICY
The FOMC ended its recent March meeting by announcing an increase of 25 basis points in the federal funds rate target from 1.50% to 1.75%. While the rate increase was expected, the FOMC also revised upward its economic and interest rate projections. The FOMC increased its GDP growth estimate for 2018 from 2.5% to 2.7%, and also expects growth to be 2.4% in 2019, higher than its previous estimate of 2.1%. The FOMC also lowered its estimates for unemployment for this year and going forward. The FOMC is becoming somewhat more hawkish in its interest rate stance, and may become increasingly so in coming quarters as inflation begins to rise.
Fixed income securities’ prices and yields were affected by a variety of factors, including the FOMC’s decision to raise short-term interest rates once again at its recent March meeting; the Trump administration’s new tariff policies on aluminum and steel imports; solid improvement in economic data; and volatility in stock prices. The administration’s new tariffs on certain imported goods were a fulfillment of one of President Trump’s campaign promises, but created concern among analysts that the gains from the recently enacted tax reform package would be undone. The economy continues to post strong gains, and the FOMC is likely to become increasing hawkish under new Federal Reserve (Fed) Chairman Jay Powell. The FOMC expects to raise short-term rates at least three more times in 2018.
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