Thursday, August 1, 2013

US GDP and the Fed

There was no change to the US Federal Reserve’s highly accommodative policy stance this morning.  That means a continuation of asset purchases of $85 billion per month and forward guidance that anticipates no change in their zero interest rate policy for a considerable period of time.

Compared to June there were a few tweaks to the July Statement.  The Committee acknowledges that mortgage rates have moved higher recently in the context of an overall strengthening housing market.  That acknowledges the importance of the improving housing market on expectations of higher growth and improving financial conditions in the period ahead.  Our assessment is the rise in interest rates to-date is unlikely to derail the improving trajectory in the housing market.

The comment “the Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance…” lent a dovish tone to the Statement.  I think that’s a nod to the challenge for the Committee in assisting the understanding that asset purchase tapering is not a tightening in monetary policy and that conditions will remain highly accommodative for some time yet.  We continue to expect that when the Committee does announce it is ready to start reducing its asset purchases it will be accompanied with a tweak to its forward guidance to reinforce that point.  Most likely candidate for that is a reduction in the “target” 6.5% unemployment rate to perhaps 6.0%.

The FOMC decision came hot on the heels of the release of June quarter GDP data which showed higher than expected growth in the quarter.  Growth came in at a seasonally adjusted annual rate of 1.7%, higher than the markets expectation of 1.0% and our forecast of 1.2%.  In fact  it came in higher than forecasts of a couple of weeks ago before most analysts revised their forecasts down, largely on the back of weaker-than-expected trade data and larger negative contribution from net exports.  Indeed net exports detracted 0.8% from growth in the quarter.

On the other side of the ledger, consumer spending, residential construction and business investment were all stronger than expected.  The biggest surprise however was that while Government spending contracted over the quarter, it was by a far smaller amount that would be expected given recent spending cuts.  This raises the risk that declines in Government spending will continue to be a drag on growth for longer.

The positive news of better-than-expected June quarter was offset by downward revisions to the four prior quarters.  March quarter growth from 1.8% to 1.1% which obviously changes my story about the June quarter being the weak quarter for 2013 growth. Given our expectation of stronger growth in the second half of the year, that dubious honour now belongs to the March quarter.

This GDP release also incorporated benchmark revisions, methodological and statistical changes.  The most significant of these was the inclusion of intellectual property production (e.g.) R&D into the business investment series.  While those revisions have lifted the level of GDP, the pattern of growth remains largely unaltered.

We expect growth in the second half of the year will benefit from the waning of fiscal drag, the continuing recovery in the housing market and stronger jobs which will all support stronger consumer spending.  Friday’s payrolls data is the next important piece of news.  We expect another solid month of jobs growth which should result a tick down in the unemployment rate, but as always, keep an eye on the participation rate.

Today’s FOMC statement, recent data and expectation of future data all support Fed tapering in the not too distant future.  However, I remain equally convinced they will not move down that path prematurely.  The release of the minutes of the FOMC meeting in a couple of weeks will no doubt shed more light.