NEW YORK (TheStreet) -- The U.S. economy hit an air pocket at the start of 2015. First quarter real GDP growth is set to come in at a meager 1.5%. Employment growth has slowed sharply, with monthly gains averaging about 200,000 this year, compared with gains as high as 300,000 at the end of 2014.
Slowdown to Prove Temporary
While discomforting, the slowdown should prove temporary. Unseasonably bad winter weather took a sizable bite out of growth, subtracting as much as 0.5 percentage point from real GDP in the quarter. The now-settled strike at West Coast ports cost the economy an additional 0.25 percentage point.
Negative fallout from the decline in oil prices has also hit the economy hard and quickly. Energy-related investment and jobs are in free fall, shaving an additional 0.75 percentage point from annualized GDP in the quarter. More cutbacks are in train, but will soon begin to fade, and the benefit to consumers from the lower oil prices should become evident.
These temporary weights on the economy total a substantial 1.5 percentage points of GDP growth. Given that the economy is expected to expand by about that pace in the first quarter, underlying growth is thus closer to 3%. This is about the growth rate expected for the year.
The principal threat to this optimism is the consequence of the surging value of the U.S. dollar. The dollar is up strongly against most currencies, and this will weigh heavily on growth. How heavily depends on how high the dollar goes. And with the Federal Reserve set to raise interest rates and most other central banks still easing monetary policy, the dollar could very well appreciate more.
Recent events challenged the view that the decline in oil prices would provide a significant boost to the economy. Based on most econometric models, including our own, if oil prices average closer to their current near $50 per barrel for the year, U.S. real GDP growth should get a lift of well more than 0.5 percentage point. The boost to consumers from paying less to fill their tanks should swamp the ill effects of cuts in energy investment and production.
To date, however, the negatives of lower oil prices have trumped the positives. The cutback in drilling activity has been vicious. Active rigs drilling for oil and gas have been slashed in half since late last year, and while the mining investment data are lagged, investment is clearly sliding fast.
This is hitting the economy hard, but the good news is that if oil prices stabilize about where they are, as anticipated, the sting will fade by the fall.
The recently softer job growth is also largely because of energy-related payroll cuts. Close to 30,000 mining jobs were cut in the first quarter, about half the jobs created in all of last year. The cutting is likely only about one-third complete, but it, too, should be largely over by the fall. Layoff announcements at large energy companies may have already peaked, judging from data from outplacement firm Challenger.
Gasoline Tax Cut
Economic benefits of the lower oil prices have also been slow to materialize. Retail sales have been especially disappointing in recent months, with core sales that exclude vehicle and gasoline purchases essentially unchanged since Halloween. Vehicle sales, while strong, have also gone sideways since this time last year.
Consumers have largely saved the proceeds from their lower gasoline bills. The personal saving rate has jumped, as households use their credit cards less and build cash in their checking accounts.
This should change soon. American households will spend close to $150 billion less on gasoline this year compared with last, or more than $1,000 for the typical American household.
They may be reticent to spend the savings lest oil and gasoline prices head back up, responding much as they would to a temporary tax cut. They may also be waiting for their savings to build before beginning to spend it.
However, if oil and gasoline prices roughly follow our outlook, consumers will soon behave more like recipients of a permanent tax cut and will step up their spending. By the second half of this year, the lower oil prices will be a clear and resounding plus for the economy.
A threat to this upbeat outlook is the surging value of the U.S. dollar. On a broad trade-weighted basis, it is up almost 15% from last summer, and vis-à-vis the Japanese yen and the euro it is up an astonishing more than 20%.
It is rare for the dollar's value to move so dramatically or so broadly against almost every other currency. It is up big against currencies ranging from the Brazilian real and the Turkish lira, to the Thai baht and Russian ruble. Even the Chinese yuan is struggling to hold its own against the dollar, for the first time in almost a quarter century.
The catalyst for the dollar's rapid appreciation was the European Central Bank's decision last fall to engage in quantitative easing. The ECB's bond-buying is so aggressive -- about €60 billion per month through late 2016 -- that many European interest rates have gone negative. That means if you lent money to the German government for a year, when the time was up you would get back less money than you lent.
Of course, that's a terrible deal, especially since if you lent money to the U.S. Treasury you would get all your money back, and then some interest. You would thus much rather invest in the U.S. than in Europe. With money flowing into the U.S. and out of Europe, the dollar is soaring against the euro. The same dynamics are playing out with the yen given the Bank of Japan's even more aggressive quantitative easing program.
Rush to Safety
The dollar also receives a boost each time a geopolitical hot spot boils over and panicked investors rush foreign money to the safety of the U.S. And there are plenty of hot spots, including those created by Russian President Vladimir Putin's belligerence, ISIS, the Israeli-Palestinian standoff, and the negotiations with Iran over its nuclear program. China's crackdown on corruption and speech has persuaded nervous wealthy Chinese to buy more American real estate, stocks and other assets.
The stronger dollar has its benefits. It should assuage concerns that the dollar will lose its status as the globe's reserve currency. That is, most trade and transactions globally are done in dollars. This reserve status provides us with enormous economic benefits.
U.S. consumers are also reveling in the stronger dollar. It pushes down the prices of imported goods, making everything from clothes to cars more affordable. Now is also a great time to travel overseas. The dollar goes much further in Paris, Rio or Tokyo than it has in years.
The decline in oil prices is also partly because of the stronger dollar. Since oil is sold across the globe in dollars, when the dollar appreciates, the price of oil in dollar terms declines; if it didn't, overseas buyers couldn't afford it.
The Cost to Multinationals
However, the loftier dollar is hurting American companies, especially large multinationals. U.S. exports are more expensive for foreign buyers, and multinationals don't make as much money in dollar terms on their overseas operations. Manufacturers whose operations are global are taking it on the chin.
With U.S. households buying more imported products and U.S. companies exporting less, the nation's trade deficit is sure to go deeper into the red. This will hurt economic growth and jobs. Based on simulations of the Moody's Analytics macro model, the dollar's appreciation to date will reduce real GDP growth this year by about 0.5 percentage point.
Simulations of the Federal Reserve's model show less of an impact, although it is still sizable.
In the Moody's Analytics baseline outlook, much of the dollar's appreciation is over, at least on a broad trade-weighted basis. While dollar parity against the euro is likely, and the Japanese yen is expected to weaken further, most other currencies should hold up better against the dollar.
The U.S. economy is strong enough to gracefully manage this scenario, in part because, despite the dollar's strength, in a broader historical context it isn't that strong. On a real broad trade-weighted basis, accounting for relative U.S. and global prices and nominal currency values, the dollar is close to its average since the adoption of freely floating exchange rates.
However, if the dollar's rise continues apace, the economic damage will mount and endanger the baseline outlook. This is a significant risk, especially given that financial markets do not appear to have fully discounted how quickly the Federal Reserve plans to normalize interest rates. Futures markets expect the federal funds rate to be near 1.5% at the end of 2017, compared with more than 3% in the Fed's forecast, and 3.5% in the Moody's Analytics baseline. If investors ultimately adjust their interest rate outlook, this could also translate into a much stronger dollar.
There is also always the potential for a currency war. In times past, countries would directly weaken their currencies to prop up their exports and economies. This beggar-thy-neighbor strategy would lead to a breakdown in global trade. While there is no currency war today, as most countries aren't overtly managing their currencies lower, there are fissures that bear close watching.
The U.S. economy's fundamentals are strong and the recent growth slowdown will be temporary. The dramatic moves in oil prices and the value of the dollar complicate things, as they prompt a shift in the sources of growth. Trade will be more of a drag and business investment will be soft, but consumers should fill the void. Assuming the biggest moves in oil and the dollar are over, at least for a while, the economy should gracefully adjust.
Want more insight? Read on:
This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.