The soft GDP read this morning sets the stage for the Fed announcement later this afternoon, with investors trying to handicap whether the Central Bank will start the tightening cycle in September or delay it further. The Fed’s assessment of the economy – particularly its view on whether the Q1 slowdown is temporary or something more enduring – will give us useful clues on that front.
The weaker-than-expected GDP report bookends a growing list of recent economic readings in recent weeks indicating that the U.S. economy had lost steam at the start of the year. As was the case in the first quarter of 2014, parts of the country faced harsh weather this year, which is believed to have weighed on economic activities in Q1, with GDP growth barely in the positive column (up +0.2% vs. +2.2% in Q4).
Weather impacts don’t last long, and the expectation is that the ‘lost’ output from Q1 will show up in the current period. Weather aside, the West Coast port closures and the impact of the strong U.S. dollar on exports could also be at play in the economy.
Some of the report’s internals, however, indicate that the Q1 slowdown may not entirely be due to transitory or temporary factors. The soft export numbers (down -7.2% vs. +4.7% in Q4) could to some extent be tied to the port issues, but very likely also reflect the impact of the strong dollar. The strong dollar is likely no going away any time soon, given the monetary policy divergence between the U.S. and its trading partners.
Beyond exports, the most disconcerting part of the report was the sharply lower fixed investments: down -3.4% in Q1 vs. up +4.7% in Q4. Some of this could be weather-related, but a likely big part is related to the retrenchment in the Energy space, which again is something more enduring. All in all, a very soft reading that could raise doubts about growth momentum the rest of the year. It will be interesting to see if Friday’s factory ISM reading for April will give us any hint that the economy was putting behind the Q1 issues behind it.
The Fed was fairly sanguine about last year’s weather-induced slowdown, which turned out to be the correct view. It will be interesting to see how they characterize the Q1 slowdown. References to the Q1 in the post-meeting statement coming out this afternoon as anything but temporary will likely indicate that the committee isn’t confident enough in the economic outlook to start the monetary policy normalization process.
The consensus view is no longer for a June rate hike, with a ‘downgrade’ to the Fed’s economic outlook likely getting interpreted to mean that even September was off the table. Any real or perceived delay in the start of the Fed tightening cycle will be seen as a net positive for stocks and should help weaken the greenback as well.
Including this morning’s reports from International Paper (IP), Eton (ETN) and others, we now have Q1 results from 276 S&P 500 members that combined account for 65.7% of the index’s total market capitalization. Total earnings for these companies are up +9.1% on essentially flat revenues (down -0.1%), with 65.8% beating earnings estimates and only 41.7% coming ahead of revenue expectations. As regular readers know, we have been unimpressed with the overall earnings picture emerging from the Q1 reporting cycle at this stage, with the top-line weakness particularly unsettling given the unusually sharp revisions to estimates ahead of this earnings season.
Related podcast interview:
Jim O'Sullivan: Low Risk of US Recession for the Next 12 Months
