Despite subtractions from trade and inventories, real gross domestic product for the first quarter of 2006 advanced at a robust 4.8 percent annual rate, defying the naysaying negativists once again. The growth of consumption plus investment (core GDP) advanced at a torrid 6.2 percent annual rate during the first quarter in real terms while nominal core GDP galloped at a 9.5 percent annual rate, the best showing since the first quarter of 2000. In other words, it’s time for those who look for weakness around every corner to take another cold shower.
Strong trends in output at home also have been met with signs of acceleration abroad. Real exports of goods and services advanced at a 12.1 percent annual rate during the first three months of the year after a 5.1 percent increase during the fourth quarter. This was the fastest quarterly rate of increase since the last quarter of 2003. Other data corroborate the notion that the global economy is accelerating instead of slowing: The Institute for Supply Management’s New Export Orders Index has risen to an all-time high on a three-month basis while emerging-market credit spreads hover closer to all-time lows.
Surely some saw signs of slippage in the March payroll report, which showed that 138,000 non-farm jobs were created during April, lower than the 200,000 expected. But wages for non-supervisory workers rose by a stronger-than-expected 0.5 percent month-over-month and wage growth was revised upward for March. The unemployment rate held at a low 4.7 percent while average weekly earnings grew at the fastest pace in nearly nine years. More remarkable is the fact that annual growth in hourly earnings has risen faster than the GDP price deflator (which advanced at a fourteen-year high of 3.2 percent during the first quarter on a year-to-year basis).
If there is a fly in the pro-growth ointment it is a monetary one: The prices-paid component of the ISM Services Index rose to 70.5 from 60.5 during April. This is well above the historical average of 58.3, meaning that inflationary pressures do appear to be seeping into the services that dominate the galaxy of U.S. prices. Price pressures also can be seen in the increasing gap between nominal GDP (aggregate demand) and real GDP (aggregate supply), an airtight refutation of the notion that strong productivity or open trade has created a permanent shield against domestic inflationary impulses. Partial-equilibrium analysis aside, the fact that the nearly decade-and-one-half high in the GDP price deflator has occurred against the backdrop of a steady advance in the core GDP deflator also suggests that upward price pressures aren’t an energy-only phenomenon.
More troubling is that any hint of a near-term rate-hike pause by the Federal Reserve has been met with steep increases in gold and commodities prices, a drop in the dollar’s foreign-exchange value, and a widening in inflation-linked bond spreads. In other words, market indicators suggest that a pause would entrench and exacerbate excess liquidity instead of mollifying or draining it. This creates a difficult situation for a Fed that continues to characterize inflation expectations as “well contained.” In fact, most of the inflation surveys suggest that inflation expectations have moved up, not down. Year-ahead inflation expectations as measured by the Conference Board came in at 5.2 percent in April, well above the ten-year average of 4.4 percent. If we smooth this series with a 12-month average, year-ahead inflation expectations are running at the highest level since 1991. Even the University of Michigan’s survey of seven-to-ten year inflation expectations has begun to show some life: Long-term inflation expectations registered 3.2 percent in April, which is above the ten-year moving average of 2.9%.
While the economy continues to confound the critics, the increasing gap between nominal and real GDP — and the bevy of sensitive-price-level and liquidity indicators flashing red — suggests strongly that the Fed remains in sub-neutral policy stance. This means that the hot nominal economy is unlikely to pitch and roll anytime soon and that core inflation almost surely will head higher instead of lower. As such, those hoping and praying for an extended hiatus in the Fed’s rate normalization process are likely to be singing the blues once again.
– Michael T. Darda is the chief economist and director of research for MKM Partners, an equity execution and research boutique located in Greenwich, Conn. He welcomes your comments here.