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Economy Starts Second Quarter on Solid Footing

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Economy Starts Second Quarter on Solid Footing

May 15, 2018

Encouraging data on U.S. consumers and businesses suggest that GDP growth is on pace for a rebound in Q2 after a shaky and quirky Q1.

Continued optimism among consumers, solid job growth, and low unemployment form the basis of our forecast for real consumption to grow near 3 percent in the medium term, with rising gasoline prices providing some downside risk.

U.S. retail sales advanced 0.3 percent month over month in April (+4.7 percent year over year), rising for the second consecutive month and securing its escape from the soft patch to start the year. The solid gains in March and April retail sales provide a high baseline for Q2 consumption (retail sales and services) and support our expectation for a bounce-back in Q2 real GDP growth led by better consumption spending. Retail sales are on pace to increase by an annualized 3.3 percent in Q2, already well above Q1’s 1.4 percent gain.

Control retail sales (excludes motor vehicles, building materials, gasoline stations, and food services and drinking places sales) that are calculated directly into GDP rose by 0.4 percent month over month in April and was revised up in February and March, indicating a higher-than-expected level of sales to start Q2. Control retail sales are on track to rise 3 percent annualized in Q2, after the 1.6 percent annualized Q4 gain, which would be closer to the underlying trend as suggested by fundamentals.

Retail sales gains have been broad-based, with 9 of the 13 primary categories increasing for the third consecutive month. However, discretionary categories of retail sales were mixed in April, with motor vehicles and parts and furniture sales rising but sporting goods, and food services and drinking places sales declining. The nominal value of gasoline station sales (+0.8 percent month over month) were boosted by higher gasoline prices and non-store retail sales (includes online) continued to rise rapidly, up 12 percent year over year. 

Higher retail gasoline prices are likely to bite into spending on other discretionary goods and services, especially as the summer driving season approaches. Retail gasoline prices are up $0.38 since the start of the year to $2.87 per gallon, the highest since November 2014. At $3 per gallon, gasoline prices may start to have a material psychological impact on consumer spending behavior.

This first key report on manufacturing for May suggests that real business fixed investment remains on track to contribute significantly to GDP growth again in Q2 and is likely to exceed 4.5 percent (annualized) for the sixth consecutive quarter.

The Empire State manufacturing index increased 4.3 points to 20.1 in May, the second best reading in the last six months, with manufacturers reporting higher demand and production levels and a more optimistic perception of the outlook after a bout of pessimism in April.

The Empire State manufacturing’s ISM-adjusted index (average of new orders, shipments, employment, supplier deliveries and inventories), advanced 1.2pts to 56.8, well above the expansion threshold of 50. Moreover, the underlying details on demand (new orders: +7 points to 16, unfilled orders: +1.3 points to 5) and current activity (shipments: +1.6pts to 19.1) all rose in May, pointing to healthy expansion in manufacturing production and elevated durable shipments for Q2.

More businesses are being faced with rising costs, with 56 percent reporting paying more for raw materials compared to 49 percent in April. Although a rising share of businesses are passing on increased prices to customers (28 percent in May, from 26 percent in April), it is much smaller than the share paying more for inputs.

The six-month ahead section of the report reversed some of its anomalous decline in April that was driven by global trade policy uncertainties and financial market volatility. Importantly, more firms planned to increase capital expenditure and technology spending in H2, suggesting that robust momentum is likely to be maintained. Sentiment surveys will continue to be important in determining the underlying health of manufacturers and any potential turning point. So far, despite the web of uncertainties and rising costs, fundamentals are shining through. 

Mickey Levy is the chief economist for the Americas and Asia of Berenberg Capital Markets, LLC, and member, Shadow Open Market Committee. 

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