For the Treasury Borrowing Advisory Committee of the Bond Market Association
A much more buoyant economy has emerged in the three months since the Committee last met. On Friday, the Bureau of Economic Analysis (BEA) announced that real GDP grew at the fastest rate in two and a half years. Payroll employment has rebounded strongly from hurricane-depressed levels last fall and the unemployment rate has receded further. Core inflation remains benign.
Real GDP grew at a 4.8 percent annual rate in the first quarter, according to the BEA's advance estimate. This followed a 1.7 percent pace of growth in the fourth quarter and was the strongest performance since the Jobs and Growth Act boosted real GDP to a 7.2 percent annual rate of growth in the third quarter of 2003.
The favorable showing comes as no surprise. By early February, the consensus of private forecasters was already predicting first-quarter growth in excess of 4 percent. In part, this represented the reasonable expectation of a rebound after a series of special factors had depressed fourth-quarter growth. Among those factors were a decline in motor vehicle sales following an outsized gain in the third quarter, a sharp rise in oil imports to offset the fall in production caused by Hurricane Katrina, and an anomalous drop in Federal spending.
In addition, it was evident that the stage was being set late last year for a stronger pace of growth at the beginning of 2006. In particular, personal consumption expenditures rose sharply in November and December, starting the first quarter off at a high level, and solid gains continued into the new year. As a result, real personal consumption expenditures rose at a healthy 5.5 percent annual rate in the first quarter of this year. The trade deficit continued to widen but by less than in the fourth quarter, as domestic oil production was restored and imports of petroleum products fell. Finally, Federal government spending rebounded in the first quarter after a decline in the fourth quarter.
Other apparently temporary restraints on growth in the fourth quarter turned around in the first quarter. For instance, investment in transportation equipment soared in the first quarter after falling in the fourth, contributing to a 16.4 percent annual rate gain in investment in equipment and software in the first quarter - a six-year record. Business investment in structures, which had been a laggard throughout the expansion, also firmed, growing at an 8.6 percent pace.
Residential investment in the first quarter rose at a 2.6 percent pace, little different from its fourth-quarter performance. Despite widespread predictions of a softening, this segment of the economy continues to hold its own after a considerable run-up over the past several years.
Overall, real GDP growth in the first quarter was very strong but because it follows on the heels of the statistically weak performance of the fourth quarter, it is reasonable to average the two quarters together to get a view of trend growth. That yields a solid real GDP increase of more than 3 percent at an annual rate.
Further evidence of an economy expanding at a solid pace is provided by labor market behavior. Employment growth stalled last fall in the wake of the hurricanes but has since bounced back strongly. Payroll job gains during the past two quarters have averaged 188,000 a month and the unemployment rate has fallen to 4.7 percent - the lowest since July 2001. Claims data from the state unemployment insurance programs suggest that labor markets remained robust through April.
Equity markets have also performed well this year, as corporate profits have continued to rise strongly. These gains are helping to boost household wealth, providing additional support for personal consumption spending.
The economy appears to be running at cruising speed, with GDP growth and job opportunities expanding at a pace that can be accommodated without inflationary pressures. Although the hike in oil prices has contributed to consumer price growth of 3.4 percent over the past year, core cpr inflation (excluding food and energy) remained at 2.1 percent in March, about where it was during 2004 and 2005.
In sum, the overall economy appears to be in a good position to continue growing at a moderate pace -likely around 3 percent - for the remaining quarters of the year. Recent developments in energy markets remind us, however, that these prospects are not without hazards. Among the most visible is the fact that consumers are once again facing gasoline prices in excess of $3 a gallon, just as they head into the summer driving season.
High gasoline prices are caused by global competition for oil, the effects of Hurricane Katrina on US. refinery capacity, as well as the rapid transition from the fuel additive MTBE to ethanol, which will entail additional costs. Exacerbating these problems is the complex system of different blends of gasoline, or boutique fuels, required by US. localities
Last week, President Bush presented a four-part plan that 1) ensures that American consumers are treated fairly at the pump, 2) promotes greater fuel efficiency, 3) boosts the supply of crude oil and gasoline, and 4) supports investment in alternative fuels to reduce US. demand for gasoline. Among the measures included in the President's program are a suspension of oil deposits to the Strategic Petroleum Reserve, temporary waivers to local fuel requirements, and a call for a better coordinated set of local fuel mix requirements in order to minimize the number of boutique fuels that refiners must produce. The program will help address the immediate needs of the American people by preventing fraud and price manipulation, assuring ample supplies of crude oil and gasoline from available sources, and promoting energy efficiency and improved production for the future.