US Economy: Where do We Stand?

Today's US retail sales report was disappointing.  Not only were January sales poor, the weakest in ten months, but both November and December sales were revised lower.   The back month revisions, coupled with recent trade and inventory data warn that Q4 GDP will most certainly be revised lower when it is released at the end of the month.  It was initially estimated at 3.2% and is likely to be revised to something close to 2.7%.  Growth here in Q1 appears to be tracking below 2%. 

 Consumers, seemingly without much use of credit cards, went on a bit of a spree in Q4, where the initial data pointed to the fastest spending in three years.  Yet over the last two months, job and wage growth has slowed.  And now consumption is off to a weak start in Q1. Next week's data includes Feb regional Fed surveys and the risks are aligned to the downside.  January housing starts also likely fell.   

There seems to be two forces are play.  One is surely the weather.  Many observers seeing a large complex economy habitually under-estimate the impact of poor weather.  January was the coldest in the US in three years, according to reports, and the snowfall was four times more than normal.  December was no picnic:  it was the coldest in four years with about a fifth more snowfall.  

The second force weighing on the US economy is the inventory cycle.  Like weather, economists, inspired in part by the adoption of just-in-time inventory management, tend to underestimate the still significant role of inventories in the quarterly swings in GDP.  Inventories were built up in H2 and will likely be run down a bit in the first part of 2014.  The inventory build in Q4 seems to have tapered off at the end of the year and while points to somewhat less growth in Q4, it is more favorable for the dynamics going forward. 

The component of retail sales used for GDP calculations excludes, autos, gasoline and building materials.  It fell by 0.3% for the biggest decline since December 2011.  December 0.7% gain was slashed to 0.3%. 

When presented with this less optimistic outlook, the first question we are asked is what is the implication for Fed policy.   In a word:  nothing, or at least not much.  The most basic reason is that the factors weighing on the economy are understood as primarily transitory in nature (weather and inventories). 

More generally, we think that the bar is high to  change the course that Bernanke outlined in December.   A weak quarter, especially one for which the data is not particularly clean, will not alter the Fed's medium term views of the underlying economy or the risk-reward of QE.  Substantively, this seems to be the message that Yellen delivered earlier this week.   Recall, some of the more hawkish FOMC voters seemed to be pushing to speed up the tapering.   No Fed official since December has appeared to advocate reducing the tapering, and clearly no one has made the case to increase the purchases again.   The so-called doves seem content to stick to the measured pace of tapering.