Consumers Continue to Power Economy

April has flown by, but we wanted to take a look at some of the recent economic data, as well as give an update on the latest troubled regional bank. Let’s dive in.

GDP

The U.S. economy grew at a rate of 1.1% in the first quarter. While this came in short of the 2% consensus estimate, if you dig deeper the report showed the consumer is still very strong. From Nick Timiraos at the WSJ:

Real final sales to private domestic purchasers (GDP less inventory change, net exports, and government spending) grew at a 2.9% annualized rate in the first quarter, the best reading since the reopening boom of spring 2021.

The chart below shows the big jump in Private Domestic Demand (which is consumer spending).

It is important to look beyond the GDP headline to get the full picture. For example, the drawdown in the volatile Inventories category subtracted 2.26% from the top line number.

Consumer Strength

One of the reasons consumer spending has remained strong is that wage growth has remained elevated. The Employment Cost Index, which measures the change in employee compensation, came in at 4.8% for the first quarter. While this is a slight decline from the high water mark of 5.10%, it is still nearly double pre-Covid levels. This is not what the folks at the Fed want to see, but we will address this next week.

Strong wage growth isn’t the only factor behind the pick-up in consumer spending. Household savings and checking account balances are still much higher than pre-Covid levels according to Bank of America. The good news is this is the case across the spectrum of income levels.

Regional Banks

Last month saw the closing of Silicon Valley Bank and Signature Bank. While financial markets were rattled for a few days, these closings did not lead to a wider banking crisis. However, it does appear there will be a third bank joining the club. First Republic Bank, headquartered in San Francisco, has seen its stock decline 96% in the last two months as speculation has grown that the bank will go into FDIC receivership, perhaps as early as this weekend.

As of Dec 31st, First Republic Bank suffered unrealized losses of over $20 billion on its loan book. Prior to 2022, the bank made many large mortgages at extremely low rates. The value of these loans plummeted as a result of the Fed’s aggressive rate hike campaign. Customers withdrew over $100 billion in deposits in the first quarter as it became apparent the bank may not survive.

Financial markets have been very resilient in the face of the regional bank struggles. Stock market volatility, as measured by the VIX, is at its lowest level since Nov 2021. Next week markets will have to digest what is widely expected to be another quarter-point rate hike by the Fed. We will have more to say then.

Many economists have been calling for the economy to significantly weaken for over a year now. And while that is typically what happens when the Fed is hiking rates, the economy has remained resilient thanks to the consumer. Jobs have been plentiful, wage growth strong, and savings accounts remain healthy.

Despite that good news, we do have concerns about the Fed potentially raising rates too high. Next week we will tackle that topic and more. We hope you have a good weekend.