Strong Manufacturing In February, But Weak Q1 GDP Likely
My favorite indicator for studying future economic growth is the ECRI weekly leading index. While the ISM reports told you growth was accelerating in the first two months of the year, the ECRI forecast growth would fall. Not only did it likely get the forecast right, it also told you this a few months before the ISM reports came out. It makes sense that Q1 will see cyclical weakness because last quarter was helped by storm rebuilding efforts. Two straight months with declining month over month retail sales results isn’t a recipe for strong GDP growth. As you can see from the chart below, the ECRI growth rate on its weekly index ticked down to 5.6%. That’s not a bad growth rate in of itself, but the trend is obviously not looking promising. After improving growth in Q3, there might be a deceleration.
The most important part of the chart above is the deceleration in the indicator last summer and fall because that’s the prediction for growth this quarter. The Atlanta Fed GDP Now model for Q1 growth has fallen to 1.8% growth from 1.9% growth. The latest decline came because the downward revisions for Q1 contributions from real consumer spending, real net exports, and real inventory investment. On the bright side, the estimate for private fixed investment growth increased from 2.4% to 3.3% because of the new residential construction report and the capacity to utilization report. The NY Fed’s GDP Now forecast has fallen from 2.83% to 2.73%. It’s still probably too optimistic. It’s down from its peak which was 3.45% growth. It’s interesting to see how the models have diverged. Speaking of divergence, the St. Louis Fed model is at 3.78% growth. I think the weak consumer prevents growth above 2.5%, but there’s still a month more of data to digest before we have a good idea of where growth will be.
Decent Philly Fed Report
In general manufacturing surveys have been strong in the past few months. The March Philly Fed manufacturing report was similar to the past few. The current activity diffusion index was 22.3 which missed the consensus for 23 and was below the prior report of 25.8. While that’s slightly negative, the six month forecast improved from 41.2 to 47.9. This is positive news because my worry is declines in manufacturing in the next 12 months will be the precursor for the next recession. The new orders index increased from 24.5 to 35.7. That might be why the six month forecast improved. The prices paid index actually declined from 45 to 42.6. That’s a big change in my eyes because these Fed surveys are where the inflation estimates have garnered their optimism. If even Fed surveys are seeing less pricing strength, it supports my narrative of disinflation. The prices received index also fell as it went from 23.9 to 20.7.
There were four special questions. The first was if there are labor shortages, skills mismatches or job vacancies which have existed for the past three months. All answers increased slightly from last year. The biggest increase was labor shortages going from 60.3% to 63.8%. Clearly, there is a labor shortage in manufacturing as job creation has been high which is unusual for the sector which has had a secular decline in job creation for decades. Because of how small the sector has gotten, this doesn’t affect my thesis that there is still slack left in the labor market.
In the second question, 41.2% of firms said there has been a significant shortage in qualified applicants. It’s interesting to see that in the third question even the basic skills of knowing how to use a computer and speaking English are becoming an issue. Those listing computer skills in the top three issues went from 24.6% to 34.5% and English skills went from 8.8% to 20.7%. Amazingly, only 50.7% of firms are paying higher wages and only 14.5% are increasing benefits because of this worker shortage. This is like how small businesses are claiming they need more workers, but they aren’t hiring as many workers as they say they need and they aren’t increasing pay. When pay increases, there will be significant inflation. I think that will occur in 2019.
Good Empire Fed Report
The March Empire Fed manufacturing index was 22.5 which beat expectations for 15 and last month’s report of 13.1. The forward expectations fell from 50.5 to 44.1 which is still high. Prices paid went from 48.6 to 50.3 which is the highest print in at least 5 years. Only 2.8% of buyers paid lower prices. The new orders index increased from 13.5 to 16.8. The prices received index increased 0.9 to 22.4 which is also the highest in at least 5 years. As you can tell, this survey is showing the manufacturing economy is running very hot. In general, it’s a bit more optimistic than the Philly Fed index.
Industrial Production: The Hard Data
In the industrial industry, the hard data is consistent with the surveys as February was a good month. The month over month growth in production was 1.1% which beat estimates for 0.4% growth and was better than last month’s -0.3%. Manufacturing was up 1.2% month over month which beat the consensus for 0.4% growth and last month’s -0.2%. Capacity to utilization was great as it came in at 78.1% which beat estimates for 77.7% and last month’s 77.4%. Mining was up 4.3%. This is the type of report that makes the Fed hike rates, but it would be wrong to only look at manufacturing in a services based economy.
Conclusion
The overall economy looks like it will probably have a setback in the first half of the year if you follow the ECRI index and the Atlanta Fed GDP model. The weakness is being caused by the consumer, not manufacturing. As I showed, manufacturing had a great month in February according to the hard data; it looks like March will be another good month according to the soft data from the Empire State and Philly Fed surveys.
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