January 30, 2013
- GDP decline misleading, Fed stays the course
In analyzing business conditions, I try to be neither too positive nor too negative. The fourth quarter GDP report provided plenty of entries for each side of my ledger.
The headlines will certainly trumpet the fourth quarter decline in the American economy, the first since 2009. While the drop was very slight (just $5 billion, or 0.1% on an annualized basis), the negative handle came as a surprise. The consensus expectation among economists called for annualized growth of just over 1%.
Encouragingly, though, the elements that contributed most significantly to the setback should not recur. Defense spending fell at a 22% annual rate last quarter, an astounding result. There had been reports of defense cutbacks in advance of the restraint called for by the fiscal cliff, but no one expected such a sizeable impact.
While the automatic reductions in Federal spending were postponed at the 13th hour, they are set to take force in March, and observers increasingly think they will take hold without alteration. Even in this event, however, it is unlikely that that defense outlays will continue to retreat so sharply. Further, inventory accumulation during the fourth quarter was significantly lower than it had been during the prior quarter. The swing in this component from above average to below average reduced reported GDP growth by about 1.3%.
We’ll be updating our forecast soon to reflect these surprises. Both will probably lead us to upgrade our expectations for the first quarter of this year.
Spending was very solid as 2012 drew to a close, with personal consumption up by more than 2% on an annualized basis. Saving rates also increased, to 4.7% in the fourth quarter. It might be difficult to sustain these trends during the early portion of this year, though. Early dividend payments, designed to front-run prospective tax increases, added to income in the fourth quarter at the expense of the current quarter. And the impacts of the payroll tax reversion and delayed tax refunds have taken a toll on household budgets and confidence.
Against this backdrop, it came as little surprise that the Federal Open Market Committee (FOMC) opted to leave US monetary policy unchanged for now. Monthly securities purchases of $85 billion will be sustained, and there was little change in the post-meeting statement regarding economic conditions. As we suspected she might, Kansas City President Esther George dissented from the decision, continuing where Richmond President Jeffrey Lacker left off.
It will be three weeks before we see the minutes of this week’s meeting. Within, we might get clarity on when the various FOMC members think that asset purchases should begin tapering off. Their assessment of the quantitative easing (QE) program will make for interesting reading.
As shown in the charts below, the downward pressure on rates applied by the Fed has boosted mortgage refinancing, and has helped contribute to strong equity markets. Of late, portfolios have been reallocating toward risk assets, which should help contribute to growth.
The risks of continued QE were outlined articulately by John Taylor in a Wall Street Journal op-ed. Higher inflation, asset bubbles, and difficulty of exit head that list. While Fed officials have been candid about their hope that portfolios will become less risk averse, there is certainly a chance that they’ll add too much risk…at the wrong price, and at the wrong time.
Central banks around the world have pursued a "low for long" policy when it comes to interest rates. Monetary discussions this year will have to focus on how low, and for how long.