The US economy growth path remains in the 2 to 3% range

The most recent retail sales numbers confirm the first quarter dip in GDP as an aberration. The US economy’s growth path, while subpar and uneven, remains on track. Some thoughts below

When I have last written about the US economy, I have said I see the US economy in a middling growth range and nowhere near recession despite the recent weak numbers. Here’s how I put it in late May:

“In thinking about this cyclical upturn, then, we should be thinking about the ability of consumer demand to withstand shocks from exports, currency, inflation, capital expenditure or inventory purges. Right now, we are at a level of wage and income growth that I believe supports a baseline of 2 to 3% real GDP growth. And so we would need to see all of these factors come to bear negatively on the US economy for it to tip into recession. In Q1 we saw these come together to produce what is likely to be a drop in GDP quarter-on-quarter. And so, to the degree these factors continue to impinge on the US economy, we should expect weakness – a weakness that delays rate hikes. I don’t think we are there yet. I believe some of these factors will wane, and that GDP growth in Q2 and Q3 will improve enough that the Fed can consider raising interest rates.”

So it is not surprising that the retail sales numbers have turned up or that the Atlanta Fed’s GDPNow model is tracking 1.9%, up sharply from just last week.

I am basically in the camp that says real wage growth is high enough to support a continued middling upswing, with deviations due to inventories, trade and capital investment taking these numbers sometimes into negative territory. The Q1 numbers may actually be revised up slightly in June and July. So as bad as they were, they are neither representative of the pace of US growth nor will they necessarily stay negative when the final print comes through.

Add to this a year-over-year decline in oil prices has shifted income to those with a greater marginal propensity to consume, and we should expect personal consumption expenditures in the 2 to 3% real growth range. Let’s remember that retail sales are actually only some 40% of personal consumption. Here’s what a chart of year-on-year growth in retail sales ex. autos looks like – not very good.

But while these figures are weak, consumers are still spending money elsewhere because personal consumption expenditures are still doing well.

Again, I don’t expect the economy to roar back to the 5% real annualized growth levels of mid-2014 but I do expect 2 to 3% growth to continue. The pace of growth has weakened though. And I believe rolling 12-month GDP and consumption growth figures will begin to decline – meaning that despite the uptick in US bond yields and the prospect of interest rate hikes, long-term bond yields will come to reflect this weakness.

The Fed looks on track to hike by September, however, but at this point I do not believe 25 basis points is going to make much of a difference in terms of market psychology or in terms of the path of the economy.