"Kee" Points with Jim Kee, Ph.D.

How is the US economy? Not great, as first quarter GDP was revised downward last week from an already weak .2% annualized rate to a negative .7 annualized rate. That’s the second year in a row that we’ve experienced a negative first quarter GDP growth number. Before going further let me say that the current data, as well as expectations (consensus, Federal Reserve, etc.), suggest a mild rebound in the second quarter and throughout the remainder of the year.


The negative first quarter number was a function of some more or less transient forces, like the seasonal component of GDP (first quarter is on average the weakest), bottlenecks caused by California port delays (labor/employer strife), and harsh weather (record cold in the Northeast). The Bureau of Economic Analysis (BEA), which releases the GDP numbers, also mentioned the expiration of the 50% bonus depreciation provision (which could be restored by Congress) as a contributor.


The economy was also affected by two not-so-transient shocks, namely the reduction in energy sector capital spending brought about by the collapse in oil prices, and the decline in exports brought about by the strong dollar. Here’s how I think about both of them:


Oil price decline: Oil prices have bounced back from their beginning of the year lows (from the $40 range to $60 dollar range), but that doesn’t mean that capital spending in the energy sector will bounce back as strongly. As I mentioned in prior Kee Points, it is one thing to make capital spending plans contingent on a hypothetical worst case scenario of below $50 oil, but it is quite another to make such plans in the wake of an actual price decline below $50. Plus, the main forces driving oil lower, like slower emerging market (China) demand growth and continued near-record output in the US and Saudi Arabia (OPEC meets this Friday) remain in place. So energy “capex” (capital expenditure) might stabilize through the rest of the year, but a strong capex spending surge is highly unlikely.


My thoughts on the dollar: I have cited for some time Nobel Laureate Robert Mundell’s assertion that a euro above $1.35 (as it was a year ago) is too strong for Europe, while a euro below $1.25 is too strong a dollar for the US. The euro broke through that bottom range last December (currently at $1.09), and the US is feeling it with lower exports (cited in the BEA’s GDP report) and lower multinational profits, just like Mundell said. Stepping back a bit, the dollar has made two “round trips” or appreciation/depreciation cycles over the past thirty years. The first, which occurred in the early 1980s, coincided with large tax cuts and deregulation in the US, which led to large capital inflows. That’s perhaps the most plausible story anyway. The second occurred in the mid-1990s and ended in 2002. That coincided with a tremendous surge in US corporate profitability as measured by return-on-investment (ROIs). ROIs increased dramatically (and remain high), and the stock market appreciated accordingly. Much of that has been attributed to the increased market for corporate control (takeover market) and/or the widespread availability of the internet (which began in earnest around 1993). I think the main point here is that the current dollar appreciation episode is not obviously like these other two. It seems to be driven by differential monetary policies among countries in a way that did not characterize the other two episodes (in addition to being driven by the dollar’s safe-haven role). And what we have seen so far is that the main impact of the recent strong dollar has primarily been its negative drag on growth.


So what is the outlook? With the passing of the transient factors mentioned above, and perhaps the worst of the two not-so-transient shocks (oil/dollar) behind us, the economy should recover through the rest of the year. That’s consistent with the latest reading of the Conference Board’s Leading Economic Index, and it is also consistent with more recent consensus numbers, with Janet Yellen and the Fed, with production numbers (durable goods, PMI indices), and with housing/auto data. The Atlanta Fed’s GDPNow forecast, which in my opinion was the closest to the first quarter GDP number, is currently measuring .8% GDP growth for the second quarter, but that will be revised (and has been, upward) as we get more data. Other forecasters are in the 2%-3% range.