If you utter the words “ hard versus soft” in Washington policy circles, it usually signals the start of an earnest foreign policy debate. Not right now, however.
For as the presidency of Donald Trump approaches its 100-day milestone, a mystery is opening up around the US economy about what the “soft” and “hard” economic signals mean. This is a debate that investors urgently need to watch - not to mention policymakers too.
The issue at stake is that if you look at recent so-called soft economic signals - those linked to sentiment - Mr Trump seems to be enjoying extraordinary success. Since he won the election, business confidence has surged: the National Federation of Independent Business survey reached its highest level in January since 2004, while the Business Roundtable CEO economic outlook survey displayed the biggest jump in the first quarter of the year since 2009.
More remarkably still, consumer sentiment jumped to a 17-year high last month in the University of Michigan’s survey. That, coupled with a fall in unemployment to 4.5 per cent and rising wages, has prompted consumers to borrow more: credit card debt rose above $1tn for the first time since 2008 in April.
But if you look at most “hard” data - statistics about tangible economic activity - Mr Trump’s presidency does not seem a success. Last month manufacturing activity dropped for the first time in seven months, along with housing starts. Retail spending fell 0.2 per cent in March, the second month of decline, while consumer prices unexpectedly slid. Corporate investment has remained flat.
As a result, the Atlanta Federal Reserve’s “Gross Domestic Product Now” indicator, which is a composite of hard data, suggests the economy grew just 0.5 per cent in the first three months of 2017. This is slower than last year. It is also well below the 4 per cent growth rate that Mr Trump promised to deliver on the election trail.
So what explains this split? The optimistic explanation is that this is merely a time lag effect. Hard economic signals tend to be backward-looking, since these capture activity that has already occurred, after a delay; soft data, by contrast, are about future expectations. So if you want to be upbeat - as many investors seem determined to be - you can argue (or hope) that this upturn in sentiment will eventually spark more tangible economic growth, as Mr Trump’s policy measures bite. It is also possible that the downbeat GDP data will eventually be revised up, since the statistics tend to be unreliable in winter, because of seasonal effects.
But there is a second, more pessimistic, theory: namely that it is actually the hard data that tell the more accurate tale. The recent surge in sentiment has been largely sparked by hopes that the Trump presidency will deliver tax reform, deregulation and infrastructure investment.
However, as Steven Mnuchin, US Treasury secretary, acknowledged to the FT this week, tax reforms have been delayed - at least “a bit” - by the Congressional spat over healthcare. And though Wilbur Ross, commerce secretary, is creating plans to roll back many of the estimated 7,000-odd regulations imposed during the Obama years, it is unclear how quickly this will occur. Similarly, nobody knows how fast the White House will implement the ambitious infrastructure plans being drawn up by Gary Cohn, chief economic adviser.
That means there is a real risk that sentiment will decline in the coming months, closing that puzzling gap between hard and soft data. If so, Mr Trump’s economic “success” will seem like just a temporary sugar high; or so the second explanation goes.
So which of these two theories is correct? Sadly, I suspect - or fear - that the second is more likely to play out. For unless Mr Ross produces a startling set of deregulation manoeuvres in the coming months, or Congress rallies around a tangible tax reform plan, it is hard to see why growth should accelerate to 4 per cent anytime soon. Indeed, the only real reason for optimism about economic activity - outside that sentiment boost - is the upturn in employment and earnings numbers.
But the one thing that is crystal clear is that investors do not appear particularly worried about this soft/hard split yet - the stock market remains sky high. Those investors had better just hope that this “mind over matter” pattern can continue for a while and that Mr Trump is able to deliver real policy reform. If not, disappointment looms.
