Help on the Way?

April 20, 2016

Help on the Way?

Michael K. Farr

US economic growth is expected to be quite weak in the first quarter of 2016, continuing a multi-year trend of weak starts. In fact, the consensus estimate for 1Q GDP growth currently stands at just +0.7% following a paltry +1.4% in the fourth quarter of 2015. One of the factors that's been weighing on GDP growth in recent quarters is exports, which, according to the Bureau of Economic Analysis, grew at an inflation-adjusted pace of just 1.1% in 2015 compared to overall GDP growth of 2.4% for the year. Prior to 2015, exports had been contributing to GDP at a pretty consistent rate of about 13.5%. In 2015, though, exports accounted for just 12.5% of GDP. This reduced contribution caused a 0.3% drag on overall GDP growth in 2015. Not huge, but not immaterial.

Two factors have been constraining exports in recent quarters: 1) weak economic growth outside the US, particularly within some of our largest trade partners; and 2) a surge in the value of the trade-weighted dollar. In the chart below, we show the clear negative correlation between the trade-weighted dollar index and US exports. As the trade-weighted dollar rose nearly 24% from mid-2014 to its peak in January of this year, US exports dropped from an average monthly rate of close to $200 billion to as low as $176 billion. This magnitude of decline in exports would translate to a $240 billion annual drag on economic growth, representing about 1.3% of total 2015 GDP.

Sources: US Census Bureau and US Bureau of Economic Analysis.

Fortunately for those companies with customers outside the US, the trade-weighted dollar has pulled back over 5% since January to roughly a six-month low. We have already seen exports bounce a bit as a result. Exports rose about $2 billion sequentially to $178 billion in February, which is the most recent data point we have. If the dollar losses are sustained, we would expect monthly exports to rise even further. By our estimates, monthly exports could rise to a level closer to the 3Q15 average of about $185 billion, all else equal. How do we arrive at this estimate? The scatter plot below shows the amount of monthly exports associated with each level of the trade-weighted dollar since late 2014 (when the strong negative correlation began). The current level for the trade-weighted dollar of about 119 is associated with exports of a little below $185 billion per month. If sustained at this level, the increase in exports would add about $7 billion per month, or about $84 billion per year, to GDP compared to our estimate for the first quarter of 2016. On an annualized basis, the increases in exports could add as much as 0.5% to full-year year GDP growth compared to a scenario whereby the dollar remained at the January highs. Again, not huge, but definitely not immaterial.

Sources: US Census Bureau and US Bureau of Economic Analysis.

Our consistent message for the past several years is that US economic growth cannot "decouple" too much from the rest of the world. Changes in currency valuations are the mechanism that limits the variance in growth. In late 2014 and most of 2015, when it appeared that US economic growth was set to accelerate and the Fed was likely to raise rates as much as four times in 2016, the dollar appreciated dramatically against the currencies of our major trading partners. The appreciation in the dollar made our exports less competitive and made imports into the US relatively cheap, both of which created a drag on domestic economic growth. Now that it is clear that the US economy remains somewhat fragile and unlikely to support aggressive Fed tightening, the dollar has pulled back. As a consequence, we expect exports to rebound. This is one factor leading us to believe that US economic growth is likely to accelerate from the weak pace of the past couple of quarters. Beyond that, though, further acceleration will likely require help from the rest of the world in the form of stronger growth.

Peace,

Michael