April 30th, 2014 9:48 am | by John Jansen |

Via TD Securities

The US economic recovery slowed to a crawl in Q1, with the economy growing at a very disappointing 0.1% m/m pace, reflecting in large part the hit from the unseasonably cold winter weather. This was a far worse performance than the market expectation for a modest 1.2% q/q advance, and it marks a sharp falloff in growth momentum after the strong performance during the second half of the year when the pace of economic growth average 3.4% q/q. There was weakness across a broad swath of the economy, with the exception of consumption spending on services, which rose at a very strong 3.0% q/q pace, adding 1.9 ppt to the top-line growth number. This, however, was flattered higher by spending on utilities (which added 0.7 ppt) and health-care (adding 1.1 ppt to growth). The boost to health-care expenditures was almost exclusively driven by Obama-related spending, which added some 0.5 ppt to 0.7 ppt to growth this quarter. In fact, outside of the spending on Obamacare and utilities economic growth would have printed at a sub -1.0% q/q level.

Beyond the Obamacare impact, there were expected weakness in spending on consumer goods, which rose at a very meager 0.4% reflecting the impact from the weather conditions. There was also big declines in spending on investment (due to weaker investment in equipment, housing and inventory), net trade and government consumption activity. Admittedly, much of this weakness could be attributed to the weather, which appears to have been more profound than previously thought. This drag should prove temporary, as we expect the rebound in residential and capital investment, along with a give-back in the inventory performance to support growth in Q2. In fact, our base-case continues to be for a robust 3.5% rebound in growth performance this quarter, and the giveback on inventory and net trade will likely provide some upside risks to this call.
The key question then becomes whether the economy is able to sustain the higher Q2 growth performance during the second half of the this year and beyond. At this point, our constructive view on the recovery remain intact as we have no reason to doubt the ability of the recovery to successfully transition to a 3.0% economy, from a 2.0% economy this year. However, this depends crucially on our expectation for a meaningful rebound in investment activity and a greater contribution form state and local government spending in coming quarters.
Naturally, this will have important implications for Fed, and consequently for the markets. Our expectation is for growth to be sustained at a higher 3.0% level over the coming year, which will provide the key justification for the Fed to continue the pivot towards a more normal monetary policy environment. However, given that this transition will be far from smooth, the Fed is likely to make any incremental step towards policy normalization more cautiously, which could eventually mean a later start to policy tightening than is being priced into the market. In that case, our base case continues to be for the Fed to make the first move on the policy rate in Q4-2015, with rising risks that a slower liftoff in the recovery will necessitate a later start to policy tightening.


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