Growth rebounds, raising questions for the Federal Reserve
August 5, 2014
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Real gross domestic product (GDP) grew at an annual rate of 4.0% in the second quarter. A large part of the strength came from a recovery in the accumulation of inventories, which added 1.7 percentage points to second-quarter GDP. Yet even excluding this unpredictable component of GDP, the underlying tone of the report was positive.
The Bureau of Economic Analysis also published annual revisions with the second- quarter report. Alterations to growth estimates indicate the U.S. economy grew at a higher pace in 2013, particularly in the second half. All this seems consistent with the thinking that this years first quarter was a weather-related aberration.
Going forward, we expect real GDP growth to track a little bit over 3% growth in the second half of the year. This outlook, if realized, will focus additional attention on the Federal Reserve and the inception of interest-rate normalization. While we are not changing our call on this front now, it is on watch.
Key Economic Indicators
Key elements of the forecast:
- Real consumer spending advanced 0.2% in June, following softer numbers in April and May. The strength in June consumer purchases provides an arithmetic advantage to third-quarter consumer spending, despite the slip in auto sales during July to an annual rate of 16.5 million units from nearly 17 million units in June.
- Business capital expenditures grew 7.0% in the second quarter, more than reversing the 1.0% drop seen in the first quarter. Given the favorable cash position of firms in the United States, the disappointing trend of capital spending remains a puzzle. The latest Duke/CFO survey indicates capital expenditure expectations as the highest since the first quarter of 2011, which raises expectations of an increase in capital spending during the next few months.
- The easing of previously tight mortgage underwriting standards is encouraging news for a housing sector that could use some. Housing starts fell in May and June, while permits for new construction showed only a mild increase for new single-family construction. Sales of existing homes moved up in the second quarter, while new home sales dipped. In all, the evidence at the moment suggests only a modest gain in residential investment expenditures during the second half of the year.
- Net exports have been a drag on GDP in the last two quarters, while the reasons have been different in each of these quarters. The first-quarter decline in exports was more than reversed in the second quarter, but imports advanced at a faster pace in the second quarter compared with the first quarters reading. The trade-weighted dollar has risen in value in recent months and suggests weaker growth in exports. The petroleum trade balance continues to decline and has helped to contain the trade gap. On balance, a modest narrowing of the trade gap is predicted for the third quarter.
- A small decline in inventories is projected to trim headline GDP in the third quarter, while federal government spending is predicted to add to GDP after only two quarterly gains in nearly four years.
- Inflation numbers are approaching the Feds 2% target. In the second quarter, the year-over-year change in the personal consumption expenditure price index rose 50 basis points to 1.6%. The core personal consumption price index, which excludes food and energy, moved up 20 basis points to 1.5%, from a year ago.
- Payroll employment is up 244,000, on average, in the last six months. Although the official unemployment rate moved up 0.1% percentage point to 6.2% in July, there is a downward trend in place.
Despite these positive trends, the failure of wages to shake off the 2.0% year-to-year trend in place for the better part of the last three years, the elevated long-term unemployment rate and a large pool of part-time employment implies considerable slack in the labor market.
- The 10-year Treasury note yield continues to hover around 2.5%, down from levels seen at the beginning of 2014. Geopolitical issues appear to be the dominant force holding down interest rates despite a strengthening of the economy.
- Inflation and unemployment readings are moving closer to the Feds dual mandate. The Fed needs to communicate to markets soon as to how it views this development and what is the nature of the exit strategy. In the meanwhile, our current estimate of the timing of the next rate hike is under review, given the nature of incoming economic data.