United States / Spotlight Reports
Q1 2019 Macroeconomic Update
by Viraj D'Costa, Senior Technical Analyst; Mario Ismailanji, Senior Technical Analyst; Rachel Hyland, Lead Analyst; Anna Amir, Lead Analyst; Ryan Roth, Lead Analyst
Jun 06 2019

The United States’ inflation-adjusted Gross Domestic Product (GDP) increased at an annualized rate of 3.2% in Q1 2019, up from 2.2% in Q4 2018, according to the Bureau of Economic Analysis (BEA). This growth is primarily a result of positive trends in personal consumption expenditure (PCE), nonresidential fixed investment, private inventory investment, state and local government spending and exports. However, rising imports and minimal increases in residential fixed investment hindered overall growth. The acceleration of real GDP growth from the previous quarter is primarily a result of accelerations in private inventory investment, state and local government spending and exports. Overall, however, real GDP increased 2.9% in 2018, compared with 2.2% growth in 2017.  Despite this growth, domestic inflation has still grown only slowly, causing the US Federal Reserve (the Fed) to stop its continual increases in the federal funds rate.

macro1

Consumer spending and labor

The US economy added a total of 557,000 nonfarm jobs in the first quarter of 2019, according to the Bureau of Labor Statistics. Another 236,000 jobs were added in April, leading to a 12-month average increase of 212,000 jobs per month. Growth in Q1 2019 was better than expected given the protracted government shutdown that extended into January. As the shutdown continued, many believed there would be a decline in nonfarm jobs.  However, the job growth in the first quarter coincided with a slight increase in the unemployment rate, which rose from 3.9% to 4.0% in January amid the impact of the partial shutdown. This then declined to 3.8% in February and March, leading to a quarterly average of 3.9%. In April, this figure continued to decline, reaching 3.6% to start the second quarter, reflecting the labor market’s continued positive development. The main sectors that fueled employment growth in the first quarter were education and health services; leisure and hospitality; and professional and business services. Growth in these sectors reflects the US economy’s shift toward services, with consumer spending on services also rising 2.0% in Q1 2019.

A declining unemployment rate and relatively stable labor force participation indicate a slight tightening of labor markets, with no sectors declining in employment aside from retail and information. This caused wages to grow during the first quarter of the year, with average hourly earnings increasing $0.87 year-over-year (YoY). With the unemployment rate remaining relatively low, companies had to increase wages to maintain current employee counts. Accordingly, average hourly earnings for nonfarm employees increased $0.18 in Q1. Average hourly earnings continued to increase into Q2, rising $0.06 in April alone to reach $27.77. Furthermore, the PCE price index increased 1.5% YoY in 2019, or 1.6% YoY when excluding food and energy.

Fixed capital investment and construction trends

Fixed capital investment also exhibited signs of growth during Q1. According to data from the Federal Reserve Bank of St. Louis, total private nonresidential fixed investment increased 1.0% to $2.89 trillion in Q1. However, this growth is slower than Q4’s 1.6% rise and represents an increase of 6.4% YoY. This significant increase in investment activity over the past year can be attributed in part to overall economic growth.

Construction spending is another method of analyzing nonresidential investment. Businesses often spend on building projects when they believe the revenue generated from new locations will remain profitable; this level of confidence helps to indicate long-term trends for nonresidential markets. In March 2019, nonresidential construction remained stable, increasing slightly to $775.2 billion from $766.6 billion in January. Construction spending was somewhat volatile in 2019 due to existing steel and aluminum tariffs that caused input costs for construction projects to increase. Additionally, with gradually increasing inflation, wage pressures have increased costs for businesses, partially limiting overall construction spending. As a result of these increased costs, contractors and businesses may have decided to delay certain projects. During Q1, the largest decline in nonresidential construction was in the religious segment, which decreased 6.6% over the quarter. Conversely, the highway and street segment increased 7.1% during Q1.

While total nonresidential construction spending increased during Q1, total residential construction activity fell. In March 2019, residential construction spending declined 1.8% to reach $507.0 billion. Much of this resulted from declining new single-family housing construction in March, though this was partially offset by rising new multifamily construction. Housing starts declined significantly during the quarter, falling to 1.2 million in March 2019 from 1.3 million in January. Similarly, housing permits also decreased to 1.3 million in March.

Similar to demand for nonresidential construction, raised prices for inputs such as steel and wood contributed to Q1’s general decline in residential construction. Residential construction was also hindered by expensive labor, the result of relatively low unemployment.

Volatility in financial markets

Financial markets experienced a return to positive growth during Q1 2019, primarily as a result of easing geopolitical tensions between the United States and China, an end to the US government shutdown and central banks becoming more accommodative amid dovish shifts in the Fed’s monetary policy. These macroeconomic developments have positively impacted US financial markets, which began the year at a low point following a steep decline in Q4 2018. Overall, in Q1 2019, the S&P 500 Index, which represents the 500 largest companies based on market capitalization, rose 13.6%.

As a result of relatively low unemployment and below-expected inflation, the Fed has changed its expected policy outlook significantly, pausing its previously planned interest rate hikes. With the economy in a late-cycle phase, meaning that it is overheated and poised to fall into a recession, the Fed has switched to a dovish monetary policy with the hope of a soft landing. On March 22, 2019, the yield on the 10-year Treasury note fell below the yield on the 3-month T-bill. When the yield curve inverts like this, it represents that investors consider short-term debt instruments to be riskier than long-term obligations, indicating a relatively pessimistic economic outlook. Historically, yield curve inversions have signaled the potential start of a recessionary period, leading to investor uncertainty and relatively low levels of consumer confidence. Nonetheless, while the next downturn is expected to begin within the next two years, this is unlikely to happen for at least another fiscal quarter.

macro2

During Q1 2019, the market for initial public offerings (IPOs) experienced relatively slow growth amid an uncertain economic backdrop. The Q1 2019 IPO market was highlighted by a relatively slow January, during which only one IPO priced, while February and March saw an uptick in activity amid the anticipated Lyft IPO. The quarter had 18 new equity issues that raised $4.7 billion in total; investors’ top concerns included uncertainty regarding paths to profitability and economic outlook, as well as the potential for companies to be participating in an end-of-cycle rush, scrambling to secure public funding before the market begins to decline. Similarly, merger and acquisition (M&A) activity in the United States increased at a relatively slower pace than in recent years, with total volume during the quarter reaching $537.6 billion, spread across 2,158 deals. Amid price increases for technology assets, companies are switching focus toward expanding products and services in existing geographic markets in 2019, according to Deloitte. Some notable deals during Q1 2019 include Bristol-Myers Squibb acquiring Celgene Corp. for $96.8 billion, Danaher Corp. acquiring GE Biopharma for $21.4 billion, BB&T acquiring SunTrust Banks for $66.0 billion and The Walt Disney Company acquiring 21st Century Fox for $71.3 billion. The BB&T acquisition of SunTrust Banks is the largest banking deal since the Global Financial Crisis and marks the possible beginning of a trend involving banks merging with one another to mitigate the rising costs of implementing online and mobile banking services for their customers.

Furthermore, regulatory and legislative changes have driven up costs for banks, such as the Financial Accounting Standards Board’s Current Expected Credit Loss (CECL) model, a new accounting standard that will take effect on December 15, 2019, with M&A as a possible option to limit the effects. CECL is expected to more-accurately represent impairments and potential credit losses in an attempt to strengthen risk-management practices and processes in the wake of the Global Financial Crisis. The current incurred-loss model only requires banks to recognize credit losses once a probable threshold of loss is reached, while CECL will focus on the “life of loan” concept. As a result, this change is expected raise banks’ credit-loss reserve levels, as well as their investment in risk analysis and reporting. Accordingly, IBISWorld research and data offers a solution for these new requirements. Our analysis of macroeconomic data and risk factors can help assess the potential of banks’ future credit-loss scenarios.

Edited by Kieran Newton