My estimate of real PCE growth for Q1 has come up about ½ a percentage point to just over 1% (ar) in response to the strong auto SAAR a couple weeks ago, the strong retail trade report for March, and slight upward revisions to core retail sales during January and (especially) February.
I notice the Atlanta Fed has moved their real PCE estimate up a bit more, although they still have weak GDP mainly because, even after correcting for the gold issue, they have almost 3 percentage points of drag from a widening net exports deficit. I am less skeptical of how Atlanta handles this trade issue than I was, because Atlanta’s bean count has changed, first by obliquely admitting that they handled gold imports wrongly and second for a more mundane reason.
They now have a huge surge in equipment investment, which might partly rationalize the huge surge of imports driving the trade drag. So, they now look less wrong, expecting the GDP to be roughly flat in their current estimate. On April Fool’s Day they had even their corrected GDP estimate down 1 ½%, which seemed clearly wrong. Not because I quibble with anything specific in their bean count, but just because huge trade drag in an environment of very weak domestic demand clearly does not pass a simple smell test. That is less an issue now.
But there are two caveats here that are separate from all that. First, we really do not have much basis for mapping the auto SAAR and core retail sales to broader real PCE these days. The convention, so far as I understand, is the one I follow of calculating the add from autos and core sales and then just extrapolating recent growth in the 2/3 of broader consumption, mostly services, that is not informed by the auto SAAR or retail sales, mostly services. That usually works well enough, because all the vol is on the goods side of spending. But in just the past two months, i.e., to February, the 3-month rate of change or real spending in that broad category has fallen from 3 ¾% (ar) to -¾%. So, we extrapolate at our peril! In working up my estimate, I pencil in growth there of 2 ½% (ar). But who knows?
Less bad, not strong, and about to hit a headwind
Source: BEA, FH estimates
Data are actual to February and FH estimate for March, inclusive of likely revisions
The second issue here is that the strength of real PCE, which I estimate at +40 bps in March, looks to have been flattered by some front running of the tariffs, which is unnerving because broader real PCE for Q1 is tracking soft despite this. And the underlying trend of real PCE ex-autos looks to be a growth rate of 1 ½%, before the hit to real income from the coming tariffs. So, I see little reason to upgrade my sense of Q2 in response to these data.
Speaking of the tariff hit, I try to be clear that I rely on my betters to do scoring of their direct impact on inflation and growth. Yesterday, the Yale Budget Lab updated their estimates and found that the tariffs – as they then understood them to be – would raise the general price level by 3 percentage points, which is obviously at the high end of the range, but it still inches up where I take the informed consensus to be on this issue.
Remember that the Fed has last mover advantage, beyond the very short run
Where I try to add value is on the point that the consensus scoring of the direct hit to growth is of little relevance outside fixed income. If you are an equity type interested mostly in whether we will have a recession, the key point to emphasize here that the realized GDP growth rate beyond the next couple quarters will be determined to a first approximation by how much aggregate demand weakness the Fed will insist upon to reverse the inflation impetus. If the tariffs slow growth a percentage point but the Fed for some reason needs two percentage points, bet on two. And vice versa. I concede that this remains an open question with much depending on how the tariffs evolve. But it is obviously worrying.
I mentioned this same point in my comments on Waller yesterday, which prompted a client to mention that folks do not understand that the Fed’s rates guidance is conditional. I strongly agree with that point, but just to be clear: I am making a stronger claim. The point is not that the Fed leadership (assuming for a moment that Waller is part of it) may be wrong on growth and therefore may have the wrong view on rates. No, my point is that even dovish sounding Fed types are being clear that they are going to accept – which basically means target, at least beyond the very short run – a meaningful slowdown of growth and rise of recession risk. Going with Waller dovish does not accurately capture that point. And it applies, more importantly, to Powell as well. If the central banker says, I don’t need to raise rates to get the recession we need to stop this inflation, then don’t take relief from that!
But we will see what happens with the tariffs.
