Sunday, February 3, 2013

Modest growth still the story for America

It was an interesting week for data out of America.  GDP for the fourth quarter of 2012 posted a small decline, the first since the GFC recession, while manufacturing and employment data for January supported the “modest growth” story.

December quarter GDP posted a 0.1% seasonally adjusted annual rate of decline, well below market expectations of a 1.0% increase.  The weakness can be explained by two factors: a sharp contraction in federal defence spending which was probably explained by anticipation of automatic spending cuts (sequestration) kicking in, and inventory investment.  Together those factors knocked 2.6 percentage points off the headline result.

Aside from those factors the result painted a picture of an economy that was expanding at a modest pace at the end of 2012.  Personal consumption spending rose 2.2%, residential construction rose 15.3% (and is becoming a real tailwind), non-residential construction 8.4% and equipment and software rose 12.4%, belying the anecdotal evidence that businesses were delaying capital spending as the fiscal cliff loomed.  In terms of net exports weakness in exports was partly offset by a contraction in imports.

More recent December month construction and durable goods (reflecting a recovery in defence spending) data suggests the December quarter GDP number is likely to be revised up when the second estimate is released in a few weeks.

In general we continue to expect an accelerating profile for US GDP growth this year with the early part of the year bearing the brunt of fiscal cliff tax changes, but the recovering housing market providing greater impetus as the year progresses.   The other factor to watch however is how federal government spending shapes up in the next few weeks as Congress resolves the spending issues in front of it.  Could well be that we have not factored in enough for spending cuts and that the fiscal drag may well end up larger than we currently anticipate.  Watch this space.

US manufacturing and employment data for January supports the modest growth story for 2013.  The January ISM manufacturing index rose to 53.1, its strongest level since April last year.  This follows several months on the trot of the index hovering around the 50 benchmark, reflecting neither strong contraction nor strong expansion. 

I’m being a tad cautious not to read too much into the jump in the overall index this month.  The most significant contribution to the overall index was a sharp increase of 8 points in the inventories index.  This reflects confidence by businesses to start adding to stock piles again once it was clear that the worst of the fiscal cliff had been avoided.  This suggests some upside risk to our pick of 1.6% for March quarter GDP growth.  I would need to see signs of stronger consumption and export growth before I believed this rise in the index suggested a sustained pickup in manufacturing output.  Indeed the export index dropped to only 50.5, reflecting still soft global growth.

The employment index rose to 54.0 from 51.9.  That, combined with the January employment report, suggests the labour market ended 2012 and began 2013 in fine fettle.  That again belies anecdotal evidence of firms holding back in the face of fiscal uncertainty.

There was something for bulls and bears in the January employment data.  The monthly payrolls gain of 157k was slightly below market expectations and the unemployment rate ticked up from 7.8% to 7.9%.  However, the data was revised back to March 2011 with recent average monthly payroll growth rising from around 150k to 180k.  That’s a tad more robust.  Remember our previous musings wondering whether the payrolls data collection was keeping pace with the structural change in the economy?

The participation rate was steady at a depressed 63.6%.  With employment looking to track along at a steady pace in the months ahead, the key number to watch is the unemployment rate, given the Fed’s “target” of 6.5%.  The participation rate will be critical to where the unemployment rate heads in the next few months.  If it stays where it is, unemployment will track steadily (though unspectacularly) lower.  However, if the better economic mood leads to an increase in people re-entering the labour market to seek work, the unemployment rate could head higher.  Fascinating.

Finally, to the Fed, the FOMC made no changes to monetary policy settings last week.  There were some minor tweaks to the language in statement which I’d summarise as being a tad more upbeat about the world.  We are at the stage in the cycle where the minutes of the meeting are actually more interesting than the statement itself and we will get those soon.  However, with the unemployment rate still elevated and the increase in the annualised quarterly core Personal Consumption Expenditure deflator having halved over the course of 2012 (from 2.2% in March 2012 to 0.9% in December 2012), don’t expect the Fed to be changing course anytime soon.