Fed grapples with seasonal blues

The Federal Reserve found itself in disconcertingly familiar territory on Wednesday morning.

Just as in 2014, the US central bank was confronted with an economy that has started the year on a poor footing, with growth disappointing even pessimistic Wall Street forecasters.

While analysts were predicting a 1 per cent annual expansion in the first three months of the year, officials on the Federal Open Market Committee were on Wednesday morning greeted with dismal gross domestic product figures showing growth of just 0.2 per cent.

First-quarter weakness has become part of a pattern. Economists at JPMorgan Chase have found that over the last 20 years, US GDP growth in the first quarter has averaged 1.6 percentage points lower than in other quarters.

Whether this is simply bad luck or a result of issues in the construction of US data, the question for the Fed is how much weight to ascribe to this subpar first quarter.

If this turns out to be a re-run of 2014, the answer should be not too much. Last year saw stellar figures in the second and third quarters, as well as job gains of more than 200,000 a month for much of the year.

However, this year there are some important differences that will weigh on Fed deliberations.

One is the surge in the dollar that started last summer. Despite a recent stabilisation, the effects are now showing through in trade data, with net exports cutting 1.25 percentage points off first-quarter growth. The currency is also putting a lid on import prices, limiting inflation at a time when the Fed wants to see price growth return to its 2 per cent target.

The second factor is the plunge in oil prices, which is having far-reaching effects on the US oil and gas sector. Weak investment in non-residential structures subtracted three-quarters of a point from output in the first quarter, due mainly to a 48.7 per cent decline in investment by oil and gas drillers.

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However as the White House Council of Economic Advisers said on Wednesday, households appeared to have put most of the oil price savings in the bank, as evidenced by a 0.6 percentage point increase in the personal saving rate over the past four quarters. Absent stronger wage growth, it seems that consumers are treating the oil price drop as a temporary windfall to be squirrelled away.

The central bank has made it clear that its decisions on when ultimately to lift rates will be driven by the data, after it ditched the forward guidance it recently gave on rate moves. Its statement on Wednesday leaves the rates outlook just as uncertain as it was going into the April meeting.

The key variables are likely to be employment reports - two are due before the next FOMC meeting in June - coupled with consumer spending data, inflation readings and wage figures.

The option to raise rates this year clearly remains firmly on the table. The Fed statement said that part of the first-quarter slowdown was down to "transitory" factors as it stuck with its central outlook for "moderate" expansion.

However it will take a while before policy makers can be confident that America's first-quarter droop is, as they hope, once again a fleeting one.

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