New Data Show Reason for Optimism on U.S. Economy

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. Despite the shock waves of Brexit, some recently released economic news leaves room for optimism about the U.S. economy. Joining me to discuss that topic is Bob Johnson. He is director of economic analysis for Morningstar.

Bob, thank you so much for being here.

Bob Johnson: Great to be here today.

Benz: Bob, let's start with the first-quarter GDP. There was some re-released data that had a revision to GDP. Let's talk about what you see when you look at that number.

Johnson: Absolutely. I think that again that's kind of older data, before the Brexit, but still it was good news to see. Recollect when we first started out, we thought GDP in the first quarter grew 0.5% with the first official government report and then the next revision got it up to 0.8% and now in this one we're up to 1.1%. So, clearly, things weren't quite as dire as everybody thought when the first release of the report came out. So that's certainly good news, it will make it a little easier to get to our kind of 2% GDP target for the year.

Again, it was a little bit of shifting in the report. Some of the consumer growth was a little bit weaker than previously thought and some of the net export data was more favorable, at least to the GDP calculation.

Benz: We've also seen consumption report released over the past week. Let's talk about that and start by talking about how they calculate that consumption data and why you pay so much attention to it.

Johnson: Let me start with that first. Consumption is 70% of U.S. GDP and it is the key driver, like people don't make investments--businesses don't make an investment if they don't see the consumers really kind of spending money. So, it even drives more than it might seem, so at 70% it's a big deal. And it's a very heavily calculated report because it involves gathering retail sales data; it involves services data which we really don't see in a lot of other reports. This is kind of the first we see some of that and this data is inflation-adjusted. So, it's very complicated data. But the bad news is because it's so complicated it comes out very late. In fact, we're here almost in July and we're now just getting data on May. A lot of other reports have been out since the beginning of the month.

Benz: So when you look at the most recently released consumption data, what do you see when you look at those figures?

Johnson: A very consistent pattern. We've seen kind of 2.7%, 2.8% consumption growth on a year-over-year basis for the last three or four months and really in that kind of 2.5% to 3% range practically back to when the recovery began. It's been much more stable than people realize driven by good wage growth and good total income growth.

Benz: Now with Brexit on everyone's radar I think the markets have certainly been trying digest what it means and consumers also have been trying to gauge what it means or does not mean for them. Let's talk about--though it's very early days for this Brexit news--let's talk about some retail sales data recently released and what it might say.

Johnson: Right. And again, it's very short-term, but we do get a weekly retail sales report and it actually showed some very, very good year-over-year improvement. We're kind of back over 3% again. Remember we like to average between 2.5% and 3.5% and we've been kind of more around 2% in the earlier months. So now we've gotten well over 3% kind of just in the last two or three weeks and this latest period did include the Friday and Saturday after Brexit. So, it doesn't appear that the U.S. consumers immediately panicked. That's for sure.

Benz: So taking a step back, I'm sure you've been thinking a lot about what Brexit means for the global economy as well as specifically the U.S. economy. Can you talk a little bit about that and share your views on what you think the impact will be?

Johnson: For everybody around the world, I think the big issue is the uncertainty and how exactly this gets implemented. And remember that world trade was already kind of slowing and that had been a big engine of growth, say, from 2005 onward. That had been a key driver as these countries traded more and more with each other and in the last year or two we've seen a slowdown in that and certainly, this whole Brexit situation is going to complicate that trade picture even more. Certainly that will tend to slow world growth as does all the uncertainty around all of this. It gives businesses and consumers an excuse to say, well, you know, maybe I'll just wait and see. So, certainly, it's not good news from that standpoint. And Europe and Great Britain trade a great deal and  what happens with that activity is a big deal. It is likely at least in the short run to be particularly harmful to the U.K. economy.

Benz: So let's talk about the U.S.

Johnson: Again, the situation is not great for anybody. But if you had to pick some place that was relatively more safely positioned, it would certainly be the U.S. economy. Remember with all the China panic we talk again and again that the U.S. is not terribly export-dependent, that it's about 12% to 13% of U.S. GDP and most major economies are more like 15%, 20%, even 25%. In the case of Germany, it's over 50%. So exports are much more important to other countries than the U.S. So, the impact of any direct export things because of world slowing or actual shipments to the U.K. are probably not a huge deal.

I'd say the second thing that makes us relatively well-positioned to others is this will probably keep a little bit of lid on the Fed and their desire to raise interest rates because now the other world economies seeing this weakness will tend to keep their rates low and that will keep pressure on the Fed to do the same. Rates lower for longer are helpful to a lot of sectors of the economy and rising rates were one of our concerns for 2016 and it's certainly not great news for banks who make the margin on the interest rates. But nevertheless, the lower interest rates are a good deal in general.

Then the other thing that's a big deal is that obviously with all the turmoil, the relative viewed security of the U.S. has caused the dollar to get stronger again and again, that limits the impact of inflation. With the strong dollar when you import goods, it come in at a cheaper price and keeps the lid at least on goods inflation. So, that's great news because my number-one concern for 2016 is inflation and certainly, this would keep a little lid at least on the goods side that will offset what we're going to see on the services side.

Benz: Rates though do have negative implications for banks. You mentioned that they will continue to struggle along here as rates stay as low as they have been.

Johnson: They will because they certainly--they were hoping that this would be the year that rates kind of went up. They are kind of wedged against the bottom in terms of gathering deposits and they don't hardly pay anything right now. The only way they will have a little bit more of a gap is if they can raise the rates on their mortgages and on their loans and with this program they are likely not to be able to do so.

On the other hand, it's very helpful for somebody like the housing industry and I think the news there would be relatively good now that we've seen how important that industry is and knowing that interest rates are going to stay low longer is very good news on that front. We saw the pending home sales data this week and they were just a little bit soft on the pendings because we're seeing more activity in the new home sales market.

Benz: Would a potential countervailing force be the fact that we have seen portfolio values fall a little bit here? Are you concerned that that nice wealth effect that a lot of investors felt might start to ebb away a little bit and people might be a little less inclined to consume if they are seeing their portfolio shrink a little bit?

Johnson: Absolutely, and I think we've already seen that and I think we've talked about a little bit that obviously we've seen some of the interest in high-end homes diminish rather dramatically and there has been a lot more interest at the low and middle sections of the housing market. So, I think there could be a little bit of reluctance to spend given what's happening to people's portfolios. Just as much on that reluctance to travel outside of the United States also could be something that's impacted here as we go through all the different situations around the world along with the Brexit situation.

Benz: Bob, always great to hear your insights. Thank you so much for being here.

Johnson: Thank you.

Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.