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Weekly Economic Commentary


U.S. Real Gross Domestic Product: Anemic First-Half, Revisions Indicate Economy Still in Recovery Phase

July 29, 2011

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The U.S. economy grew at an annual rate of 1.3% in the second quarter after a downwardly revised 0.4% increase in the first quarter (previously estimated to have increased 1.9%). From a year ago, real GDP advanced only 1.6%, the smallest increase in the current recovery.dgc 729 1Annual benchmark revisions indicate that the Great Recession has recorded a deeper decline in real GDP (-5.1%) during 2007:Q4 to 2009:Q2 compared with the prior estimate (-4.1%). Revisions also point to the fact that the U.S. economy is still in the recovery phase (see Chart 2). Previous estimates had shown that the economy entered an expansionary phase in the first quarter of 2011.

dgc 729 2Consumer spending held nearly steady in the second quarter, equipment and software spending rose 5.7% in the same period. But, both of these components of real GDP show a slowing trend (see Chart 3).

dgc 729 3

The 3.8% increase in residential investment expenditures was a surprise; however, on a year-to-year basis, residential investment outlays remain negative.

dgc 729 4Exports rose at an annual rate of 6.0% in the first quarter, representing a slowing trend on a year ago basis. Federal government spending shows a sharp deceleration on a year basis (see Chart 6). Further cutbacks in federal government spending should translate into trimming headline real GDP growth in the quarters ahead after a soft patch in the first-half of 2011.

dgc 729 5dgc 729 6The overall GDP price index moved up at an annual rate of 2.3% in the second quarter vs. a 2.5% gain in the first three months of the year. The personal consumption price index, which the Fed tracks closely, increased 3.1% in the second quarter vs. 3.9% in the first quarter, reflecting the moderation in energy prices. The core personal consumption expenditure price index, which excludes food and energy, rose 2.1% in the second quarter vs. a 1.6% reading in the first quarter. This price measure is at the top of the Fed’s threshold of tolerance. Given projections of economic growth that are below potential in the second-half of 2011, inflation measures are predicted to show a moderating trend. Inflation expectations have moved up slightly in recent days (2.11% as of July 28, 2011, see Chart 8) but the level is still noticeably below the recent high of 2.45%. Inflation expectations are not indicative of impending inflationary pressures; thus, allowing the Fed to watch and wait.

dgc 729 7

dgc 729 8The Fed is on hold in the near term, given that QE2 (quantitative easing) has been completed as of June 2011. Today’s second quarter GDP report and downward revisions of the prior quarters suggest that the economic recovery is fragile and the sub-par performance could require additional monetary policy support in the near term. Another round of quantitative easing by year-end is entirely conceivable if economic growth remains soft.

dgc 729 8bIn In related news, the Employment Cost Index (ECI) rose 0.7% during the second quarter, matching the increase seen in the prior quarter. Benefit costs advanced 1.3% in the second quarter, after a 1.1% gain in the first quarter. Benefit costs have accelerated from a 2.5% increase in the second quarter of 2010 to a 3.6% jump in second quarter of 2011 (see Chart 9). Wages and salaries have held in the 1.5% - 1.6% range for almost two years (see Chart 9). Total employment costs have risen gradually over the past year to record a 2.2% year-to-year gain in the second quarter of 2011 compared with a 1.9% gain in the second quarter of 2010 (see Chart 9). The bottom line is that employment costs are not threatening inflationary pressures, for now. If the economy were to gather strong momentum during the second-half of the year, this contained employee cost scenario could change.

dgc 729 9

Japan Will Get A New PM, But When?

by Ieisha Montgomery

If all goes to plan, fingers crossed, in the next month Japan will get its sixth prime minister in the last five years, and the country will finally be able to focus firmly on reconstruction. The Japanese are accustomed to getting a new PM once a year, but Naoto Kan’s tenaciousness in clinging to power is a novelty in recent times. Japan’s beleaguered leader made a pledge to resign on June 2; however, he is holding on to power against the wishes of his own Democratic Party of Japan (DPJ), the opposition, and, most importantly, the Japanese public. All indications are that Kan will either resign or somehow be forced out by the conclusion of the current parliamentary session at the end of August.

Kan promised his resignation in return for his party’s support on a no-confidence measure brought by the opposition Liberal Democratic Party (LDP); however, he incensed politicians when he laid out three conditions for his exit. First, the PM insisted on the passage of a supplementary budget to help fund the disaster recovery. This condition was satisfied when the second supplementary budget was passed by the Diet on July 25. Next, Kan wants a law that will ensure utilities are paid a premium for generating electricity from renewable sources. Finally, he wants a bill that will allow the government to issue bonds to fund a large portion of next year’s budget. The DPJ hopes to get both bills passed by mid-August, but the LDP is loathe to pass the deficit funding legislation without an agreement to cut entitlement programs such as child-care payouts and Kan’s exit.

Both parties are also wary, and rightfully so, of Kan attempting to hold on to power even if all three of his conditions are met. The prime minister is increasingly speaking like a man who does not intend to give up power within a month. It is possible that he might attempt to cling to power by claiming that he wants to steer the country to a nuclear-free future. Under this scenario Kan could dissolve parliament and call snap elections in an attempt to capitalize on prevailing anti-nuclear sentiment; however, he has publicly denied the possibility that he might call fresh elections this summer. Mr. Kan claims that the Japanese public does not want an election, which is true, but a more likely motive lies in the fact that his approval rating is so low that an election would be the equivalent of political suicide.

If Kan refuses to resign, both the DPJ and LDP have options at their disposal, but only the DPJ’s plan has a genuine chance of success. The LDP could pass a non-binding censure motion in the Upper House where it maintains a majority, but that would essentially be an official statement of what Mr. Kan already knows – nobody wants him to stay in office. This move would embarrass both the DPJ and Mr. Kan, but it would not force him to resign. The poison pill being considered by the DPJ, which is ultimately responsible for getting rid of the PM, involves the mass resignation of party executives and members of the Cabinet.

If Mr. Kan has any concern about his political legacy, and most politicians do, he will resign by the end of August before a LDP censure vote or DPJ resignations. His exit will clear the way for the DPJ to appoint a new PM and put in place the third extra budget, which will be the large reconstruction budget the disaster area has been awaiting. Unfortunately, there is still not much hope that the politicians will stop the bickering and infighting long enough to come up with viable options to Japan’s long-term problems.

The opinions expressed herein are those of the author and do not necessarily represent the views of The Northern Trust Company. The Northern Trust Company does not warrant the accuracy or completeness of information contained herein, such information is subject to change and is not intended to influence your investment decisions.