Debt Debate, Anticipated Weakness

The debate over the debt ceiling continues with the government now approaching its fourth month of?“extraordinary measures.”?While Democrats have petitioned for a?“clean”?increase, Republicans have largely been opposed to an increase without provisions regarding a reduction in future spending.??

?

Of course, regardless of which side one supports, the consequences of dragging out the saga or worse, failing to raise the debt ceiling, impact all.?

?

According to Treasury Secretary Janet Yellen,?failure to raise the debt ceiling and resulting in a default on U.S. government debt would lead to an?"economic catastrophe."?“A default would raise the cost of borrowing into perpetuity. Future investments would become substantially more costly,"?Yellen said.

?

In this week’s Economic Insight?“The Threat of Default Looms as Investors Anticipate Resolution,” we take a more in-depth look at the debate and the potential consequences of prolonging the debate, as well as the risks of default.?

?

Former Treasury Secretary Larry Summers also warned of dire consequences for the U.S. economy, as a result of earlier policy decisions to keep rates low and implement massive stimulus during the pandemic. Speaking at the Morningstar Investment Conference in Chicago earlier today he said, this country has moved from one of 2% inflation to 5%. Thus, going forward, returning the economy to price stability will require a significant slowdown in the economy.?

?

“I think we’re going to have difficulty getting near a 2% inflation target until and unless the economy slows down substantially,”?Summers said.?

?

Yesterday,?continuing the trend of regional manufacturing weakness seen earlier in the week, the Richmond Fed Manufacturing Activity Index dropped five points to a reading of -10 in April, surpassing the decline to -8 expected, a two-month low and the fourth consecutive month of a negative print.

?

In the details of the report, new order volume fell from -11 to -20, and order backlogs ticked down from -14 to -31 in April, a three-month low. Additionally, shipments dropped from +2 to -7, and capacity utilization decreased four points to -14 in April. On the other hand, the number of employees rose by five points to a reading of zero at the start of the second quarter.

?

Bottom Line:?While all slightly different in the sector and region of focus, broadly speaking, regional indicators have signaled an ongoing decline in activity under the weight of slowing domestic consumption reflecting elevated inflation, minimal wage growth and a drawdown in savings, as well as a drain in international demand as an elevated dollar distorts the costs of American-made goods.

?

Also yesterday, the FHFA House Price Index rose 0.5% in February, the largest gain in nine months. According to the median estimate on?Bloomberg, the index was expected to decline 0.1%.

?

The S&P Case-Shiller 20-City Home Price Index, meanwhile,??unexpectedly rose 0.06% in February following seven consecutive months of decline. Over the past 12 months, the 20-city index rose just 0.4%% over the past 12 months, down from the 2.6% annual increase in January. On a national level, home prices rose 0.2% in February, but improved 2.1% over the past 12 months, down from the 3.8% rise in January.

?

Additionally, new home sales?unexpectedly jumped 9.6% in March from 640k to 683k, a one-year high. According to the median estimate on?Bloomberg, new home sales were expected to decline 1.3% at the end of Q1. Over the past 12 months, however, sales fell 3.4%, the thirteenth consecutive month decline. Due to a rise in sales, the months’ supply of new homes ticked down from 8.4 months to 7.6 months. From a price standpoint, the median cost of a newly constructed home rose 3.2% from the month prior to $450k. Year-over-year, new home prices increased 3.2%.

?

Also yesterday, confidence?declined from 104.0 to 101.3 in April, a nine-month low. In the details of the report, a gauge of current conditions rose from 148.9 to 151.1, while a gauge of future conditions dropped from 74.0 to 68.1 at the start of the second quarter, the lowest reading since July.

?

Bottom Line:?While the U.S. economy is likely to show a 2.0% gain in the first quarter come tomorrow’s release, the underlying momentum in topline growth appears to be increasingly weaker looking out to the second half of the year as rising borrowing costs?and still elevated inflation continues to take a toll on consumers’ ability to spend. Thus, a deteriorating trend in consumer optimism led by an erosion in the assessment of further conditions suggests this weaker outlook is not entirely lost on the consumer, particularly as shoppers are forced to turn to a further drawdown in savings and credit cards to make everyday purchases in the wake of fading fiscal stimulus and still negative trending growth in real income.?

This morning, durable goods orders rose 3.2% in March, the largest monthly gain since December and following two consecutive monthly declines. According to the median estimate on?Bloomberg, durable goods orders were expected to rise 0.7%. Year-over-year, headline orders rose 4.6% in March, up from the 2.0% annual increase the month prior.

?

Transportation orders jumped 9.1%, following a 3.1% decline the month prior, due to 78.4% rise in civilian aircraft orders. Vehicle and parts orders, however, fell 0.1%. Excluding transportation, durable goods orders rose 0.3% in March and increased 0.5% over the past 12 months.

?

Capital goods orders rose 8.7% in March. Nondefense capital goods orders, meanwhile, increased 10.4%, following a 2.3% drop in February. However, capital goods orders excluding aircraft?and?defense – a proxy for business investment – fell 0.4% in March following a 0.7% decline the month prior. Year-over-year, business investment increased 2.0%, down from the 3.6% annual gain in February.

?

In other details, computers and electronics orders rose 1.9%, and electrical equipment orders rose 0.8% at the end of Q1. Also, fabricated metals orders, primary metals orders, and machinery orders all rose 0.1% in March.

Bottom Line:?While a welcome increase in headline orders, the dip in core orders excluding aircraft and defense – a proxy for business investment – indicates a larger declining trend in corporate outlays than expected. That being said, the disappointment in the details of this morning’s report will not be enough to derail expectations for a solid Q1 GDP report largely predicated on the resilience of the consumer. Still, looking out to Q2 and beyond, it appears businesses are already curtailing expenditures, perhaps in preparation for additional volatility or anticipated weakness ahead.?

?

Also this morning, wholesale inventories rose 0.1% in March, as expected and following a similar increase the month prior.

?

Tomorrow, the?first read on Q1 GDP. At the end of last year, GDP was unexpectedly revised lower one-tenth of a percentage point to a 2.6% increase on an annualized basis in the final Q4 report. The resilience of the consumer at the start of the year will expectedly keep growth in positive territory across the first three months, likely surpassing many earlier forecasts. Nevertheless, growth is expected to post a markedly reduced pace relative to Q4 with downside risks to topline activity going forward as consumer activity presumably continues to slow with Fed tightening threatening to push the economy into recession.?

?

Later in the week, on Friday, the latest income and consumption figures will be released, along with an updated read on the PCE. This month, the PCE is expected to rise 0.1% in March and 4.1% over the past 12 months. The core PCE, meanwhile, is expected to increase 0.3% at the end of Q1 and 4.5% year-over-year, down only a tenth of a percentage point from the month prior.

?

?-Lindsey Piegza, Ph.D., Chief Economist?