Strong Economic Growth in Q117 and a March Fed Rate Hike?

Strong US economic growth appears to have continued into Q117, which risks raising the odds of a Fed rate hike in March.  There, of course, are a lot more data to come before the March FOMC Meeting, and some of the recent strength may be transitory.  But, further strength could elicit Fed-hawkish reactions in the markets -- stocks lower and Treasury yields and dollar higher, with Yellen's mid-February Semi-Annual Monetary Policy Testimony becoming the closer event that could solidify increased odds of a March hike.

Last week, Yellen was somewhat uneven in her comments on the economy.   In one speech, she said that the economy appeared to be close to self-sustaining growth.  In another, she repeated the Fed line that growth is expected to be moderate and that this supports gradual unwinding of monetary policy stimulus. 

Further evidence of economic strength also could lessen the perceived need for some of Trump's fiscal stimulus proposals.   It would not be surprising if Yellen is questioned on this aspect of the proposals at her mid-February testimony.  A pullback in fiscal stimulus would be a negative for stocks.  Note that the possibility that Trump may fail to provide sufficient detail about his proposals remains a downside risk to stocks, as well, as I argued last week.

The recent economic strength may reflect an upturn in the oil industry, better economic growth abroad, faster growth in labor income, and higher business confidence stemming from the pro-business focus of Trump's policy proposals.  It also could reflect mild weather so far this winter -- helping economic activity, such as construction, and freeing up household monies that otherwise would be spent on heating.  This weather boost is in contrast to the weather drag in the past two winters, but it would be temporary  -- the larger the weather boost to Q117 GDP, the smaller the weather boost, if not a pullback, in Q2 and Q317.  So, the current economic strength should not be extrapolated ahead fully.  And, there may be some reversal of near-term market moves in the Spring. 

Initial Unemployment Claims are the broadest measure that so far suggests a speedup in GDP Growth in Q117.  While the low prints in the last week of December and first week of January could be attributed to difficult seasonal adjustment in holiday weeks, the further decline in the week after New Year's -- reported last Thursday -- ran counter to what would be expected if that were the case.  Mild weather could have been behind the latest week's decline in Claims.  Claims need to stay low, trending below the 257k H216 average, to point to a speedup in Q117 Real GDP Growth.

                   Initial Claims (level, 000s)
Jan   14         234
Jan     7         249
Dec  31         237

Q416            256
Q316            258

The ECRI Leading Index also suggests a continuation of strong growth, as it has been on a sharp uptrend since October.

ECRI Leading Index (level)

                                                 Weeks
              7/16                                                             10/16    1/17


The Fed models are projecting above-trend growth in Q416 and Q117.  The Atlanta Fed model continues to forecast 2.8% (q/q, saar) in Q416, but it missed the large jump in agricultural exports in Q316, and thus may miss a pullback in these exports in Q416 -- putting downside risk to its 2.8% estimate.   The NY Fed model sees 2.1% in Q416 and 2.7% in Q117, both up from the prior estimates of 1.9% and 2.1%, respectively.  (Stronger Industrial Production data were responsible for the upward revisions to the NY Fed forecasts.)  Consensus also is for 2.1% Q416 Real GDP Growth.   All these estimates can change next Thursday, when the last pieces of data that feed into GDP are released.  The actual first-print of Q416 Real GDP will be reported the next day, Friday, January 27. 

A near-consensus GDP print would not likely be high enough to significantly boost market expectations of a March Fed hike.  But, it would not rule the latter out, either.  It would be above the 1.5-1.75% range considered to be trend, as mentioned by San Francisco President Williams in a speech last week.
 


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