Looking beyond inventories
November 20, 2013
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Inventories have the habit of offering surprises in reports of real gross domestic product (GDP). The third quarter GDP report was one such occurrence, with inventories making an unexpectedly hefty contribution. A reversal of this event is most likely to influence the headline GDP number in the final three months of the year.
The partial federal government shutdown in October trimmed growth slightly in the fourth quarter. Combining this with the adverse impact of a likely reduction in inventories, real GDP is predicted to have advanced only 1.6% in the fourth quarter. If the fourth quarter forecast is accurate, it would work out as a 2.0% increase in real GDP from a year ago. The economy is predicted to grow at a stronger pace in 2014.
Key Economic Indicators
Key elements of our forecast
- Consumer spending has maintained a steady 1.9% annualized growth trend in the first three quarters of 2013. Auto sales slipped slightly in October but are holding close to the pace seen prior to the 2008 crisis. Higher equity and home prices have lifted the net worth of households, which is supportive of stronger consumer spending. More importantly, the impact of the 2013 tax hike, which held back consumer spending, will be absent in 2014 and boost consumer spending.
- The Institute of Supply Managements survey of new orders and the Vistage CEO Confidence Index (responses from chief executive officers of small- and medium- sized companies) are solid leading indicators of business equipment spending. The recent trends of these measures point to a reversal of the 3.7% drop in equipment spending seen in the third quarter.
- The Federal Reserves latest policy statement noted that housing market momentum has slowed somewhat. Incoming housing sector data present a mixed picture. The Housing Market Index of the National Association of Home Builders held steady in November, while sales of existing homes failed to advance in the each of the three months ended October. The Mortgage Purchase Index of the Mortgage Bankers Association fell in October and the first two weeks of November but rose during the third week. The Housing Affordability Index declined to the lowest level since mid-2009. The upward trend of home prices remains encouraging, while the pickup in hiring in the three months ended October is another bright spot.
- Federal government spending policy has been extraordinarily tight in 2013. In January, the payroll tax cut expired, while tax rates for higher income households were raised and spending was reduced due to sequestration. According to the Congressional Budget Office, the cyclically adjusted federal budget deficit in fiscal year 2013 stood at 2.5% of GDP, significantly smaller than 4.3% reading of 2012. Contraction in the budget deficit of this magnitude in the last five decades has occurred only twice.
Under current law, fiscal restraint in 2014 is smaller than in 2013. Moreover, state and local government spending and employment are turning around. Therefore, fiscal headwinds are not likely to severely restrain economic growth as much in the quarters ahead.
- The contribution from exports is likely to be modest. The third-quarter GDP report of the eurozone was disappointing; real GDP advanced only 0.1% after a 0.3% gain in the second quarter. The European Central Bank (ECB) lowered its policy rate based on widespread trends of disinflation. However, the lack of lending in the eurozone and structural challenges overwhelm financial accommodation of the ECB. Therefore, exports of the United States to this economic bloc stand to be affected.
- The Fed meets on December 17 - 18; it will consider tapering asset purchases amid lingering fiscal uncertainty and the pending transition in leadership. The November U.S. job report (released in early December) will be a critical input to the conversations.
- Markets have mostly brushed aside fiscal uncertainty for now, but conditions could change as the deadlines for a compromise on spending, taxes and the debt ceiling get closer. For now, equity prices are buoyed by incoming Fed Chair Janet Yellens message of a balanced approach to asset purchases.