Construction spending edged up only 0.1% in February after contracting a bit in January. A 2.1% drop in public sector construction mostly offset a 0.7% jump in private sector construction. A silver lining appeared in the upward revisions to the data for December and January. Unseasonably cold, snowy weather in some regions suggests we will see another weak month when the data for March are released.
Declines in public sector construction were widespread. Construction on federal projects fell at a double-digit pace; the drop in state and local spending was in the low single digits. State and local construction spending, which accounts for the lion’s share of infrastructure investment rose only 0.3% from one year ago. The municipal bond market has taken a hit in response to the federal tax cuts, which make tax-free municipal bonds less attractive. This is hurting the ability of state and local governments to raise funds for projects, many of them infrastructure.
Separately, high-tax states are scrambling to try to do a work-around to address the new limits on state and local tax deductions, also included in the broader tax cuts. Many are skeptical that the states will be able to achieve workarounds, which could represent another
blow to infrastructure funding
at the state and local levels.
This is all despite promises of increased infrastructure spending from the administration. Congress has shown little appetite, however, to fund more spending after the behemoth spending bill just passed, which means that spending on public infrastructure will suffer. The situation is becoming fairly critical in some areas of the country where improvements and simple maintenance have been shelved. I saw more than the usual number of potholes on roads and bridges when traveling this past weekend.
Gains in private sector construction were better but not spectacular. Construction spending was only up 3.4% from one year ago despite a bounce-back in February. Gains in residential construction activity outpaced the total but they are still not enough, especially in the single-family home market. Escalating land and materials costs coupled with acute labor shortages have held back the supply of new homes for sale and hindered repairs following last year’s disasters.
Gains outside of residential construction were mixed. Lodging remained positive but slowed dramatically from the pace we saw earlier in the cycle despite record-high occupancy rates for many hotels. The sticking point is room rates, which have fallen after adjusting for inflation. Airbnb and websites offering discounted hotel rates are the primary culprits. Demand for travel remains strong.
Retail showed some gains but remains in the red from a year ago. The exception is warehousing, which reflects the ongoing shift from in-store to online shopping. Construction spending on general merchandise stores, which are among the hardest hit by the shifts to online shopping, posted a double-digit monthly gain but that was off nearly 25% from one year ago. The data was compiled before a flurry of store closings announced since February.
Manufacturing remains weak despite some signs of strength. This year we are seeing the baton handed from the vehicle sector, which had been the one bright spot in the broader manufacturing sector. Orders in the heavy manufacturing sector picked up in the second half of 2017 before the tax cuts. A weak dollar, stronger growth at home and abroad all contributed. We are still waiting to see orders translate into more infrastructure. The data on industrial production suggests we are finally absorbing the excess capacity left by the crisis. The investment needed to bring plants back online again will be substantial. Some plants in the construction industry have been idled since the onset of the housing bust in 2006.
Separately, the Institute for Supply Management (ISM) edged lower to 59.3 in March from 60.8 in February. That is still well above the 50% threshold that indicates expansion in manufacturing. Inventories dropped, while prices continued to accelerate; that is news the Federal Reserve will welcome if price increases get passed onto consumers. The Fed has been waiting for a warming trend in inflation for some time.
Spending on public sector construction continues to disappoint. We should be seeing stronger gains in the private sector, particularly on single-family housing but that is constrained by supply problems. The result is less overall construction activity than usual this late in the cycle, especially in terms of public infrastructure. There do not appear to be any quick fixes for our crumbling public infrastructure situation in the near term. The first quarter is coming in below 2%.
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