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A Somewhat Softer Outlook

May 1, 2013 · Update in PDF PDF

Economic indicators released in April were slightly softer than those released earlier in the year, dimming the outlook for above-trend growth. Output growth accelerated from its crawl at the end of last year but came in below expectations, and the details suggest that its momentum in recent months is roughly unchanged. Employment gains were weaker in March than the brisk pace of the previous few months; however, more reports are needed to confirm that the pace has slowed. Inflation has fallen below 2 percent, and measures of underlying price pressures suggest it cannot be entirely blamed on transitory influences.

Output Accelerated, Momentum Ambiguous

Real gross domestic product (GDP) grew 2.5 percent annualized in first quarter 2013. This was a significant acceleration from the previous quarter’s rate of 0.4 percent but somewhat below professional forecasters’ expectations of 3.0 percent. Expectations were relatively high due to the composition of the previous quarter’s weakness, as inventory investment and government consumption and investment sapped a whopping 2.9 percentage points from growth. Outside of business-cycle turning points, both of these components tend to exhibit little persistence—weakness in one quarter does not indicate likely weakness in the next. In fact, large negative contributions are often followed by large positive contributions, and vice versa. So, if these two components at the very least stopped being a drag on growth while other components continued to grow at roughly their fourth quarter 2012 rate, growth should have been well above trend. Half of this story played out, as inventory investment contributed 1 percentage point to growth in the first quarter. However, government spending, particularly on defense, continued to decline (Chart 1).

These two components largely canceled each other out in the first quarter, and thus the 2.5 percent headline rate is a relatively clean read on the momentum of the economy, unobscured by the components that have driven much of the volatility after the early stages of the recovery (Chart 2). At a several-quarter horizon, it is generally safe to assume inventories will average a zero contribution to growth. Currently, the same cannot be said for government. The spending cuts mandated by the Budget Control Act of 2011, popularly known as the sequester, did not take effect until April. As a result, government spending will likely be a drag on growth through the rest of the year.

Personal consumption expenditures (PCE) contributed 2.2 percentage points to growth, as consumers accelerated spending despite the expiration of the payroll tax cut and the looming sequester. Nonresidential fixed investment slowed appreciably from its healthy rate in the previous quarter, offsetting the improvement in consumption. Residential investment continued its steady growth but remains at too low a level to drive a robust recovery. The stream of improving data earlier in the year raised hopes that the recovery would finally reach a breakout pace in 2013. While this report on output growth was solid, there is little in it to suggest that growth over the next few quarters will be any better than the tepid recovery average.

Labor Market Recovery Remains Uneven

Like the GDP report, nonfarm payroll employment in March came in under expectations, raising fears of another spring slowdown. Payroll employment increased by only 88,000, below the average in January and February of 208,000 and consensus expectations of professional forecasters of near 200,000. According to the more volatile household survey, from which the unemployment rate is derived, the economy shed 206,000 jobs. Despite this, the unemployment rate fell to 7.6 percent from 7.7 as an even larger number of workers left the labor force. The employment report wasn’t all doom and gloom, though. Aggregate weekly hours worked increased at 3.7 percent annualized, above its average of 2.4 percent since 2010. The number of workers who were part time for economic reasons declined noticeably, as part-time workers were converted to full time. Even ignoring these bright spots, the headline employment numbers on their own should not be enough to substantively change one’s outlook on the strength of the labor market. Monthly payroll numbers are subject to large revisions, with an average magnitude of 80,000 over the subsequent two reports. The first-quarter growth rate of 1.7 percent, a slight acceleration from the fourth quarter and on par with the recovery average, is more likely to withstand revision.

But has the recovery pace translated into an improved labor market faced by the unemployed? According to the red line in Chart 3, which shows the probability of an employed person becoming unemployed in a given month, the labor market has made substantial progress. It corroborates the path of initial jobless claims—the risk of the employed losing their job has headed down throughout the recovery and is now near normal levels. Alternatively, the red line in Chart 4, which shows the probability that an unemployed person will become employed in a given month, plummeted in the recession and has remained flat ever since, other than a small step up at the beginning of 2011. Instead, the blue line has trended higher as it has become more likely that an unemployed person would drop out of the labor force than find employment. The two reds lines tell the story of a two-speed labor market recovery. The employed no longer face a heightened risk of becoming jobless, while the unemployed see little improvement in prospective employment.

Underlying Inflation on the Downslide

Headline PCE inflation fell to 1.0 percent over the 12 months ending in March 2013—the lowest year-over-year rate since October 2009. Energy prices, the usual culprit of extreme headline inflation rates, fell 1.6 percent but were not primarily responsible for the weakness—inflation excluding food and energy prices was only 1.1 percent (Chart 5). Trimmed mean PCE inflation, a more reliable measure of underlying inflation, has also steadily fallen from its late-2011 peak to 1.4 percent in March, raising concerns that inflation over the coming year will fall short of the Federal Open Market Committee’s 2 percent longer-run goal. Underlying inflation according to the Consumer Price Index (CPI) has been higher and more stable but is also trending down. CPI inflation tends to run roughly 0.3 percentage points above PCE inflation, so rates near 2 percent are consistent with the soft price pressures already described.

An acceleration of growth from modest to moderate is still possible over the course of the year despite the fiscal drag on the economy, but such an acceleration did not materialize in the first quarter after a healthy first two months. The labor market continued to improve at the lackluster pace that has characterized the recovery, and there are no obvious signs of a pickup in the near term. Inflation is low, and above-target inflation over the next year does not appear to be a threat.

—Tyler Atkinson

About the Author

Atkinson is a senior research analyst in the Research Department of the Federal Reserve Bank of Dallas.

 

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