Over the last several months, we’ve seen a significant amount of encouraging US economic data. Most notable is the fact that consumer confidence ended last year at the highest level since 2007, and small business optimism was the highest since 2004. Both indexes have continued to rise this year.
With confidence at these levels, one would expect the economy to be much stronger by now.
There’s been similar improvement in the “Direction of Country” polls since the election. Notice in the chart below how the black line (right direction) has improved significantly since the election. And the red line (wrong track) has steadily fallen. This is a significant improvement in the last several months.
We thought the economy was on a roll when we learned last year that 3Q GDP growth vaulted to 3.5% (annual rate). Yet 4Q GDP disappointed at only 2.1%. For all of 2016, GDP grew at less than 2%, despite the spike in the 3Q.
Surely GDP growth has accelerated this year, you must be thinking. We continued to see mostly positive economic reports over the last few months. Yet according to the Atlanta Fed’s “GDPNow” real-time daily tracking indicator, the economy has been trending lower since early February, falling to only 0.6% (annual growth rate) last week, as you can see below.
So what’s the problem? With consumer confidence so high and small business optimism way up, why is that not translating into surging spending by consumers and small businesses? Here are some of the reasons why.
Concern About Fed Rate Hikes. Over the last couple of months, it has become clear that Yellen & Company are serious about raising the Fed Funds rate at least two more times this year and at least three more hikes next year.
Many small business loans are priced off a variable interest rate known as “LIBOR” (London Interbank Offered Rate) which moves in lock-step with the Fed Funds rate. As the Fed Funds rate increases, so will small business borrowing costs.
Credit Problems on the Horizon. If we learned nothing else from the financial crisis of 2008, it’s that credit is what makes the business world go around. It’s the grease that lubricates the wheels of capitalism. And that’s one place where the stresses are starting to show.
Weakening credit demand and tightening lending standards were noted in the latest Federal Reserve Board Senior Loan Officer Survey. It is a really bad combination. It means that people who want a loan will find it harder to get one. Fewer loans are bad for the economy.
Small Businesses Remain Cautious. The National Federation of Independent Business Small Business Optimism Index hit a new high of 105.3 in February, up from 94.4 last August. Yet the same survey found that the percentage of small businesses planning a capital expenditure in the next three to six months fell to only 26% in February. That’s really low.
Put simply, if small businesses were really as optimistic as they say they are, why aren’t they splurging on new equipment? Truly optimistic business owners would be spending on equipment so that they could prosper from any forthcoming acceleration in growth. The fact that the number planning to do so has dropped speaks volumes.
Automobile Inventories Are Rising. Car sales are slowing this year. Sales of cars and light trucks fell to an annualized rate of 16.62 million in March from 18.43 million in December, according to the Commerce Department. Meanwhile, unsold cars and trucks keep piling up in inventories at automakers and dealerships. So they are slowing down production.
Automobile production involves many important suppliers including the makers of steel, glass, plastic, paint, rubber and copper, just to name a few. So a car industry slowdown isn’t just a slowdown for auto companies. It’s a big deal.
Private Investment Spending Down. Private non-residential fixed investment (PNFI) declined for the first three-quarters of 2016 with a modest uptick in the final quarter, according to the Fed. PNFI includes factory buildings, machinery and other things needed for production.
This decline in investment spending led to the first annual decline in productivity in 2016 since 2009, as I explained in detail in my April 4 E-Letter. No investment equals no productivity growth.
These are just some of the reasons we are experiencing disappointing economic growth despite very strong confidence on the part of consumers and small businesses. I suspect they are also waiting to see if President Trump can deliver on his promises of tax cuts and deregulation.
I’ll have more to say on this topic in the weeks and months ahead.