Narrowing Trade Gap Positive for Q2 GDP, Looking for the Phillips Curve
- The U.S. Trade Gap narrowed in April, to -$46.2 billion, improved from February’s wide -$55.5 billion.
- Productivity Growth for the first quarter was revised down from 0.7 percent to 0.4 percent.
- Mortgage Apps for the week ending June 1 jumped by 4.1 percent.
The nominal U.S. international trade gap narrowed for the second consecutive month in April after widening in the fourth quarter of last year and again in the first quarter of this year. After adjusting for prices changes, trade was a big drag on 2017Q4 real GDP growth, subtracting 1.2 percentage points, resulting in a 2.9 percent annualized growth rate for Q4 real GDP. Revised trade and GDP numbers now show that trade was neutral for Q1 GDP. With just one month of data for the second quarter, it looks like trade will be a positive factor for current quarter GDP, contributing to our expectation for a moderate-to-strong 3.6 percent annualized growth rate for Q2 real GDP. Total exports increased by $0.6 billion in April with help from petroleum exports. Imports declined by $0.4 billion with fewer cell phone imports after the surge last fall.
Productivity growth for Q1 was revised down to just a 0.4 percent annualized rate. Nonfarm business sector labor productivity is defined as output per hour of employees. Low productivity growth implies that companies will need to increase their prices as wage rates increase. Conversely, high productivity growth implies that wage gains will not necessarily lead to product and service price increases. Related to productivity is unit labor cost, the cost of labor required to produce a unit of output. When productivity growth is higher, the change in unit labor costs tends to be lower. Unit labor costs for nonfarm businesses increased at a 2.9 percent annualized rate in the first quarter of this year, and were up by 1.3 percent since 2017Q1.
Headline numbers for productivity and unit labor costs often mask what is happening in individual industries, but they give us insight into the relationship between overall wage growth and price growth. What they are telling us now is that wage gains due to current tight labor market conditions will tend to squeeze corporate profits, requiring companies to increase prices. Related to the productivity/unit labor cost discussion is the Phillips Curve.
The Phillips Curve is a model used by economists to show the relationship between the unemployment rate and the rate of inflation. According to the Phillips Curve, as the unemployment rate decreases, inflation tends to increase. There is an active debate in economics about whether the Phillips Curve is holding up in this business cycle. We believe that it is still a useful macroeconomic tool, but that it requires a more refined analysis in the presence of persistent deflationary forces (including lower population growth, increased international trade and increasing computerization). Former Federal Reserve Chairwoman Janet Yellen was a proponent of the Phillips Curve. She set the Fed on a path of increasing the fed funds rate from the end of 2015 through early 2018 in response to the growing potential for higher inflation. As new Fed Chairman Jay Powell puts his stamp on the organization, we believe that he will continue the course started by Janet Yellen, and increase the Fed funds rate at least two more times this year, once next week on June 13, and again on September 26. Another rate hike is possible on December 19 depending on how the economic data looks in the second half of the year.
Mortgage applications jumped by 4.1 percent for the week ending June 1, with similar gains in both purchase and refi apps. This was the first increase in purchase apps in seven weeks, a hopeful but weak sign for home sales.
Market Reaction: U.S. equity markets gained after the open. The yield on 10-Year Treasury bonds is up to 2.96 percent. NYMEX crude oil is down to $64.51/barrel. Natural gas futures are down to $2.88/mmbtu.
For a PDF version of this report click here: International-Trade-06062018.
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