Inflation-adjusted Gross Domestic Product (GDP) exhibited moderate growth during the first quarter (Q1) of 2018, increasing at a seasonally adjusted rate of 2.2%, according to revised estimates from the Bureau of Economic Analysis (BEA). This stable growth has been reflected in an overall expansion of the US labor market and uncharacteristically low unemployment levels. At the same time, the market for workers in the United States has continued to tighten in recent months, in line with the gradual aging of the US population and an increasing number of discouraged work-age individuals who have left the labor market rather than pursue full-time employment. In turn, the market’s oversupply of vacant positions relative to qualified candidates has forced many employers to increase average wages to remain competitive, contributing to strong growth in total consumer spending during Q1 of 2018.
The early months of 2018 have also been characterized by moderate growth in private fixed investment and increased construction spending on utilities and offices, as well as a multi-year high in the value of US initial public offerings (IPOs). In addition to several high-value IPOs for biotech, music streaming and cloud storage companies, the video streaming platform iQiyi Inc., commonly described as “the Netflix of China,” raised a substantial $2.3 billion for its IPO in March 2018. Such strong IPO activity has been complemented by an uptick in mergers and acquisitions (M&A), as well as overall growth in the S&P 500. At the same time, financial markets have also been constrained by wavering investor confidence, as strong employment growth has exacerbated concerns over future interest hikes. Additionally, the possibility of escalating trade wars with major US trade partners has created substantial uncertainty in key US markets.
Labor Market Tightness
In recent months, consumer and employment outcomes in the United States have largely been shaped by the prolonged tightening of the US labor market, which has supported rising average wages and increased consumer spending. For one, steady economic growth has caused the US unemployment rate to reach its lowest point since December 2000 (3.9% as of April 2018). This figure falls well below the natural rate of unemployment, and has placed pressure on employers to increase average wages to attract and retain qualified workers in this increasingly competitive hiring market. This upward pressure has also been supported by a consistent decline in the share of the US population that participates in the labor market. According to data from the Bureau of Labor Statistics (BLS), the US labor force participation rate (LFPR) has contracted over the past two decades, declining from 66.0% in 2008 to an estimated 62.9% in Q1 2018. This trend has picked up speed in recent years as members of the substantial baby-boomer generation have continued to enter retirement.
According to BLS data, average hourly earnings have grown 2.6% over the past year, reaching an estimated $26.84 in April 2018. In turn, rising incomes have enabled US consumers to increase spending on a wide variety of goods and services, resulting in a $50.0 billion increase in US personal consumption expenditures (PCE) in March 2018 alone. This figure includes a substantial $26.8 billion increase in service-related expenditures, driven by rising fuel prices and stable demand for household electricity and gas. The value of US consumer spending has also been supported by inflationary pressures, as tight labor market conditions have forced many businesses to raise prices to remain profitable. Over the past year, the Personal Consumption Expenditure Price Index (PCEPI), the Federal Reserve’s preferred measure of inflation, has posted 2.0% growth. However, the gradual raising of interest rates has caused this inflationary growth to taper off in recent months.
In line with overall economic growth, an estimated 638,000 nonfarm jobs were added to the US economy during the first three months of 2018, according to data from the Federal Reserve. Combined with low levels of unemployment, this influx of employable workers reinforces the tightness of the US labor market. At the same time, a significant number of potential workers remain excluded from US labor market estimates, with the number of marginally attached workers (individuals who are available for work, but who have not looked for employment in the past four weeks) reaching an estimated 1.4 million individuals in April 2018. Similarly, the US workforce includes an estimated 5.0 million involuntary part-time workers who would prefer full-time employment.
Fixed Investment and Construction Trends
Private fixed investment continued growing moderately in Q1 of 2018. Expressed in chained 2009 dollars and seasonally adjusted at annual rates, private fixed investment grew 1.6% in Q1 2018. While this is slower than the previous quarter’s growth of 2.0%, it still outpaces growth of 0.8% and 0.6% experienced in Q2 and Q3 2017, respectively. Furthermore, a 2.2% growth in nonresidential investment has outweighed a 0.5% decline in residential investment in Q1 2018. In particular, nonresidential structures and intellectual property products grew at rates of 3.4% and 2.6%, respectively.
When analyzing nonresidential investment, construction spending data can be used to identify certain long-term trends in nonresidential markets. For instance, construction spending on power and offices increased 2.7% and 5.0%, respectively, in Q1 2018. This development in power markets represents a reversal of the general trend exhibited in the previous year, as overall construction spending in power declined 0.5% from Q1 2017 to Q1 2018. Conversely, construction spending in healthcare declined 3.9% in Q1 2018, despite being up 7.5% a year ago.
While housing permit growth is up 8.7% compared with levels a year ago, growth has nonetheless stagnated in 2018, declining 0.1% in Q1. However, when a six-month moving average is applied, housing permits are still trending upward. This suggests that the actual rate of expansion is not yet declining, reflecting the strong fundamentals of the expanding economy. While there appears to be some downward pressure on residential investment, likely stemming from supply-side uncertainties and potential interest rate hikes, the slowdown appears only minor.
Volatility in Financial Markets
Mergers and acquisition activity and IPOs have surged during the first half of 2018. As of June 5, 2018, 100 IPOs have been filed, as opposed to 80 in the previous year. Such growth is indicative of exuberant business sentiment in the United States, which has persisted despite turbulence in the stock market. The S&P 500 has not yet eclipsed the record highs it reached earlier in the year, causing some investors to shy away from equities in favor of fixed-income investment vehicles. The first months of 2018 have also been characterized by a series of high-value IPOs, including the debuts of Spotify, Dropbox and other major technology platforms. Overall, the US IPO market raised an estimated $15.6 billion across 44 IPOs during Q1 2018, the market’s largest quarter by proceeds since 2008. More specifically, surging IPO activity has been driven by the expanding biotech sector, including companies such as ARMO BioSciences Inc. and Menlo Therapeutics Inc. Overall, biotech companies accounted for about 25.0% of all IPOs filed in Q1 2018.
Increased volatility in US financial markets can be partially explained by macroeconomic developments in the domestic economy, as well as shifting geopolitics on the international stage. For one, a tight labor market and rising inflation have sparked concerns that the Fed will be aggressive in raising its federal funds rate target in coming months. The Fed has recently indicated that it expects to raise its federal funds rate target two more times in 2018, to reach 2.25%. With the federal funds rate inching toward prerecessionary levels, investor uncertainty will likely be on the upswing. The likelihood of tariffs being imposed on steel and aluminum imports from Canada, Mexico, the European Union and other major US trading partners has also exacerbated investor uncertainty in recent months. This protectionist shift in US trade policy would significantly benefit producers of raw steel and aluminum in the United States, though import tariffs would also substantially increase input costs for US car manufacturers and other domestic industries that currently rely on inexpensive imports. The medium-term ramifications of such geopolitical developments remain unclear, but stand to intensify volatility in the overall markets.
Edited by Sean Egan. Designed by Emily Lidstone.
Industry Impact: Construction; Healthcare; Finance; Car & Automobile Manufacturing
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