A Signal from the Trade DeficitMichael Englund
The U.S. trade data for March, trade prices for April, and the University of Michigan Consumer Sentiment index for May reinforce the notion that gross domestic product (GDP) growth sharply exceeded official estimates in the first quarter -- but is poised for a slowdown in the second quarter that will spell good news for the Fed.
The combination of trade price strength and commodity price gains, however, suggest this encouraging pattern in the "real" economy is occurring alongside a more problematic pattern in the inflation figures.
The U.S. trade deficit narrowed to $62 billion in March, from a revised $65.6 billion in February. Imports slipped 0.8% after a 2.6% drop in February. Exports rebounded 1.9%, more than making up for the 1.6% slide in February. The deficit with China widened to $15.6 billion, from $13.8 billion, while the deficit with OPEC stretched to $8.1 billion, from $7.3 billion. The deficit overall is much narrower than expected.
The big deficit drop in March implies a likely sizable overshoot for GDP in the first quarter. Our GDP estimate for the first quarter has now conservatively been raised to a 5.8% annual rate, well above the 4.8% advance reading released last month.
With hindsight, the Bureau of Economic Analysis (BEA) did indeed lowball all the missing source data for the quarter, and any downside surprise from the initial first-quarter report will now diminish. In fact, all the major GDP components now face asymmetric upside risk that could manifest itself in either a GDP figure north of 6%, or a larger chain price gain for the quarter.
"FIRST CLEAN READING."
It's clear that the GDP went through a big zigzag -- caused in part by hurricane disruptions -- between the fourth quarter and the first. We have reduced our second-quarter GDP estimate to 4% because of the "pull ahead" of growth implied by the boost to first-quarter GDP. It's noteworthy that the four-quarter GDP growth average as of the second quarter will end up near 4% as well.
Although the 4% figure we project for GDP in the second quarter will "feel" like a slowing to the market -- and will likely produce some real-sector monthly data that will encourage the Fed to pause -- the number may best be seen as the first clean reading on growth following three disrupted quarters, and a strong one at that.
The real slowing in the economy, beyond some short-term disruptions that may be related to the renewed gasoline price pop, should come in the second half of the year rather than the first.
In total, it looks as if it will be the inflation figures that drive the Fed decision at the June FOMC (Federal Open Market Committee) meeting. In this regard, the firm trade price figures, the falling dollar, and the ongoing uptrend in a wide range of commodity prices will keep the Fed in play over the months ahead (see BW Online, 5/10/06, "An Ongoing Eye on Inflation").
The import price figures revealed the petroleum price jump that we expected, but core import prices look ready for gains through the second quarter as well, and export prices appear solid.
The natural-gas price unwind of the first quarter provided some near-term price relief, but the second quarter may be dominated by the impact of firming global commodity prices and the pricing power associated with dollar declines. Core inflation figures over the coming two months, in particular, will receive close analysis from the markets and the Fed.