The budget deal clears the way for Congress to increase spending on a variety of programs, including infrastructure.

The U.S. economy is poised to pick up some speed this year given indicators for capital expenditure and the large budget agreement. The economy is likely to benefit from the fiscal spending package ushered in by President Trump and Congress a few weeks ago. Similarly, we expect to see a positive impact from the budget deal on economic growth. While we can debate how much of the impact will be nominal and how much will be real, the economy is likely to grow a little more quickly in 2018 because of the stimulus.

With a strong labor market, it would seem that stronger GDP growth would certainly bring the Fed into play. The Fed raised interest rates three times in 2017, referencing an improving economy and labor market. If the economy continues on this trajectory, then four interest-rate hikes this year will become the base case scenario.

Data indicators mixed

While manufacturing and confidence remain high, other data has been weak. Housing and auto numbers are normalizing after the post-hurricane boost in the fourth quarter of 2017. In addition, consumer spending growth cooled, gaining only 0.2 percent in January. Many growth trackers suggest that first-quarter GDP growth could come out well below a seasonally adjusted 2.0% quarter on quarter.

Despite the mixed outlook, the underlying story of the economy remains good.

Despite the mixed outlook, the underlying story of the economy remains good. The labor market is the best indicator of this. The February data showed very strong job gains. What is interesting is that the wage data came in weak; January’s jump in average hourly earnings was not repeated last month. However, there are a couple of things that are worth noting: Wage growth in manufacturing is now quite rapid, while quit wages and wage growth in leisure are falling. Although leisure is a large sector, it’s a low-wage segment, and it is interesting that labor market tightness is not producing wage gains at this point of the wage/skill distribution.

Trade policies negative for the economy

We wrote at some length last month about the threat of protectionism, and it’s fair to say that the risks of a policy mistake have risen quite sharply over the past few weeks. With the resignation of Gary Cohn, President Trump’s chief economic advisor, the nationalist/protectionist wing in the White House has gained ascendancy. While the Republicans on Capitol Hill retain their attachment to free trade, the presidency has autonomy in matters of trade. It’s also worth recalling that opposition to free trade is one of the few ideological positions that President Trump held with anything approaching consistency over the years. Despite his firmly held beliefs, tariffs will not close the U.S. trade deficit, absent higher savings (in the public or private sectors) or lower investment.

The President’s recently imposed tariffs are not, in and of themselves, likely to have material macroeconomic effects even if they will shift profits around the economy and create some unwelcome distortions. However, there are real reasons to worry. Firstly, a tariff is least disruptive if it applies across the board, but these tariffs are being implemented as a negotiating tactic, which just creates incentives for firms to engage in genuinely unproductive behavior. The second concern is what it suggests may be coming, and it’s hard not to be discouraged on this front. Large scale interventions in trade now seem reasonably likely, and these will certainly draw retaliation from other countries. The European Union has developed some expertise in retaliation, choosing U.S. exports that are made in places dominated by the political supporters of the protectionists. We believe the Chinese will likely follow the European example, and it would be very easy for them to pick on U.S. agricultural exports.

In the space of the last month, we’ve gone from an environment where policy was supportive of the growth outlook to one where policy is creating serious downside risks.

We’ll have to wait and see how serious this is, and ask how much retaliation will there be and how far will the Trump Administration push things? We can’t quite yet quantify this into a GDP forecast for 2018 and 2019. However, in the space of the past month, we’ve gone from an environment where policy was supportive of the growth outlook to one where policy is creating serious downside risks. These might not materialize, of course, but we find it hard to be optimistic.

Next: China’s new emperor


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Evidence of economic strength, including a tight labor market and rising wages in the United States, drove Treasury yields higher.