Incoming data has tended to disappoint. While weather impacts are taking part of the blame, I tend to think that part of the blame should fall on overly optimistic interpretations of data patterns at the end of 2013. In particular, the recently downwardly revised GDP numbers were less than spectacular abstracting away from inventory effects:
Looking at real final sales, I see slow and steady, or even a modest softening, not magic acceleration. Similarly, aggregate hours worked never signaled a dramatic change in the pace of activity (unless, of course, one suspected productivty was exploding):
Slow and steady is also the underlying message of the most recent Beige Book:
Reports from most of the twelve Federal Reserve Districts indicated that economic conditions continued to expand from January to early February. Eight Districts reported improved levels of activity, but in most cases the increases were characterized as modest to moderate. New York and Philadelphia experienced a slight decline in activity, which was mostly attributed to the unusually severe weather experienced in those regions. Growth slowed in Chicago, and Kansas City reported that conditions remained stable during the reporting period. The outlook among most Districts remained optimistic.
Also note that domestic demand will appear disappointing as long as trade is supporting the GDP numbers:
The swing in the contributions from net exports means that a smaller increase in domestic demand is necessary to boost overall GDP.
The latest data disappointments were the weak ADP report suggesting a just 139k private sector NFP gain in March and a similarly weak reading on the service side of the economy from ISM. Bill McBride notes that the ADP is not exactly a great predictor of the preliminary employment numbers. Very true. At the same time, however, they are generally consistent with the underlying trend in labor markets over time. As such I do not discount them entirely. In this case, the ADP report may also be confirming the softness seen in the ISM services report, particularly in the employment component:
One important anecdote:
- "The Affordable Care Act is creating significant financial uncertainty to healthcare organizations. With little warning, the negative impact on revenue has been unprecedented." (Health Care & Social Assistance)
See also Matthew Boesler at Business Insider. I think this was already evident in the pace of health care hiring, which has slowed to a crawl:
There will be two ways to view this story. In the near-term, it will be a negative given the constant support the sector has provided for employment over time. In the long-term, this might be an optimistic sign that the focus of the industry is turning aggressively toward achieving productivity gains. Higher productivity is an important to containing health care costs (it has been estimated that productivity growth was negative between 1990 and 2010), but will depress the demand for labor in the sector. This process may already be under way.
Inflation remains below target:
Headline inflation has edged up, but remains well below 2%, and core inflation does not show signs of acceleration:
My baseline expectation for monetary policy is that recent softer data makes little difference in the tapering plans. The Fed wants out of asset purchases and can always fall back on the "progress toward goals" excuse to pull the plug on the program. Moreover, as I said earlier this week, I believe Fed officials will become increasingly nervous about the inflation outlook as unemployment approaches 6%. They want to be done with asset purchases before they have to worry about raising rates. Weak data, particularly if it passes through to the unemployment rate, will have more of an impact on the timing and pace of interest rate hikes than tapering. With this in mind, it is not surprising that rates have sagged since the beginning of the year:
Monetary policymakers anticipate the first rate hike will be sometime in 2015. The exact timing is dependent on the evolution of activity and the fear of overshooting. At the moment, the Fed's expectation of around 3% growth looks optimistic. But even the sub-par growth to date has been enough to drive down unemployment. This opens the door to the possibility that the Fed raises interest rates despite sub-par growth. This depends, however, in a large part on Federal Reserve Chair Janet Yellen's opinion. In today's swearing-in ceremony, Yellen said:
I will also continue the work of helping repair the damage done by the financial crisis to the economy. Too many Americans still can't find a job or are forced to work part-time. The goals set by Congress for the Federal Reserve are clear: maximum employment and stable prices. It is equally clear that the economy continues to operate considerably short of these objectives. I promise to do all that I can, working with my fellow policymakers, to achieve the very important goals Congress has assigned to the Federal Reserve.
That sounds like she is not worried about overshooting in the least. My suspicion is that she will need to see real evidence that labor market slack has evaporated in the form of faster wage growth before she begins to worry of overshooting. This suggests Yellen's expectation of the first rate hike is deeper in 2015 than some of her colleagues.
Bottom Line: Data disappointment in part is driven by excessive optimism. In any event, data are not sufficiently disappointing to derail the Fed's tapering plans. Unless activity lurches sharply downward, I think the tapering process is pretty much on autopilot. It is now all about interest rates.
