Friday, August 30, 2013

The US data week, tapering and Syria

It wasn’t that long ago that we thought June quarter GDP growth would be the weakest of the year in America.  After the release of the first revision overnight on top of the broader benchmarking revisions in July that lopped a bit of growth off the March quarter, it looks like Q2 will end up being one the strongest of the year.

June quarter growth was revised up from the initial estimate of a seasonally adjusted annual rate of 1.7% to 2.5%.  The market consensus was for a 2.0% result.  That followed growth of 1.1% in the March quarter.  The surprises were a sharp upward revision to non-residential construction while the contribution from inventories was revised up when the expectation was it would probably be revised down.

Other revisions were broadly as expected with net exports revised up and government spending revised down.  Recall the modest fall in government spending in the advance GDP estimate had us thinking there was a risk fiscal drag would take longer to play out.  The revision in government spending from an annualised -0.4% to -0.9% over the quarter reduces that risk somewhat.

Higher growth in Q2 is good news for the Fed as it contemplates tapering its asset purchase program.   More generally however, the data is better described as “mixed”.  Labour market data continues to look good.  Initial jobless claims are at 6-year lows and we think payrolls will print at around +175k in August.  Consumer confidence also printed higher this week.  On the downside, durable goods fell more sharply than expected in July and housing data was a bit softer than expected.  The impact of rising interest rates and its likely dampening impact on the housing market was a topic of some conversation in the July FOMC minutes.

On balance there’s now an element of downside risk to my Q3 GDP growth pick of an annualised 2.2%, but  we continue to expect that growth will be stronger in the second half of the year than it was in the first (1.8% vs 2.4%).   However our forecast leaves the annual rate of growth for calendar just below the FOMCs forecast range.

Tapering is now factored into markets. To that extent the actual timing of when they start is now largely irrelevant.  As I said last week, just getting on with it has the added benefit of removing the uncertainty.  But I still think, given the outlook for growth and inflation, that there is a good chance the FOMC will surprise on the dovish side with the pace of tapering and the assertiveness of its forward guidance.

Finally on the other cause of a bit of market volatility this week: Syria.  Early in the week it appeared intervention was imminent, at the end of the week that was less certain.  Markets have reacted to the news as expected through the week with an initial “risk off” response which reversed during the week as immediate intervention appeared less likely.  The politicians, especially in the UK, are taking an understandably cautious approach.

You will recall that when we do our annual “things to watch out for this year” list, geopolitical tensions always features somewhere on it. From a portfolio perspective that’s why diversification matters.  Given our view on interest rates we are often asked why we maintain an albeit underweight allocation to global bonds.  The answer is it’s still a fragile world, from both an economic and political perspective.  When things go bad, you still want to have an allocation to bonds.  We will be watching developments closely. 

Thursday, August 29, 2013

Turmoil in emerging markets: NOT a repeat of 1997

One of our most often used phrases with respect to emerging markets is that while they don’t suffer the same structural problems as many post-GFC developed economies they have plenty of their own to contend with.  Events of the last few days, especially in some of the larger high current account deficit countries such as India, Indonesia and Brazil, are a recognition of those challenges as the US Federal Reserve looks to start tapering its asset purchase program.

The issue is that Fed tapering means reduced global liquidity at a time when some emerging market current account deficits have been deteriorating, admittedly for some time, requiring greater capital inflows to fund them.  It never ceases to amaze me how financial markets tend to react to current account deterioration in some countries including New Zealand; the deterioration is tolerated until, quite suddenly, it’s not.

The recent deterioration in current account balances has been significant.  I have focussed on Indonesia, India and Brazil given that in US dollar terms these deficits are amongst some of the largest in the world.

I tend to be more accepting of current account deficits in emerging markets.  From an economic development perspective it makes sense that developing countries should run current account deficits as investment is front-loaded before incomes have risen sufficiently to generate a pool of domestic savings.  But that’s only OK if what we are seeing is a gap between savings and investment rather than excessive consumption.  I am actually more concerned with some emerging country budget deficits and the high costs of domestic subsidies (for fuel for example) than I am about their current account deficits.  Of course getting budget deficits under control improves national savings which will in turn assist with the current account deficit.

But I digress.  Some have likened the current situation to a repeat of the 1997 Asian Financial Crisis (AFC).  I disagree. For a start, exchange rate regimes in Asia are typically more flexible now.  Exchange rates have depreciated significantly in recent months; the Indian Rupee is down 20% this year and the Indonesian Rupiah is down 12%.  Furthermore, banks in Asia are in better shape than they were in 1997 and foreign exchange reserves are much higher.    In South America, the Brazilian Real is down 12.5% this year.

Also, external debt is lower now than it was in 1997.  Remember the Asian economies worked hard to improve their financial positions following the AFC.  Regular readers will know I subscribe to the “saving glut” theory as the genesis of the GFC.  Strong export-led growth post the AFC led to significant current account surpluses (i.e. emerging market savings) which were “consumed” by the developed world with America acting as borrower of last resort.  Be careful what you wish for.

We think we are actually on the verge of an improvement in many emerging market current account deficits.  A number of factors will contribute to this including the recent exchange rate depreciations which will improve export competitiveness and will act as a constraint (depending on elasticity of demand) on import growth.

Of course the currency depreciation will be inflationary but that is likely to be transitory.  That said, we think it’s still likely that Indonesia raises interest rates soon and while India has raised some interest rates to support capital inflows, we think they will be back to easing later this year on the back of weaker growth and relatively contained underlying inflationary pressures.  In Brazil the central bank has been raising interest rates, the latest move a 50bp hike this morning, but we think lower growth means inflation is unlikely to reach the heights we expected just a few months ago which means interest rate increases are nearly done.

We have also progressively lowered expected growth rates in India and Brazil this year. We now see India growth at 5.6% this year with Brazil likely to come in at around 2.0%.  With respect to the current account, weaker domestic demand means less import demand.    Also remember that from global growth perspective a relatively strong Japan and stabilisation in China and Europe are providing some offset.  In fact we look for stronger growth in developed economies over the next few quarters to support emerging market export growth.

So we don’t think the current situation is anywhere near as dire as it was in 1997. Indeed we expect some improvement in emerging market current account deficits over the next few months.  However the recent angst highlights that the need for growth enhancing structural reform is not just a developed market phenomenon.  In the meantime, expect concern around key current account deficit emerging economies to linger until some turnaround in their external positions becomes clear.

Thursday, August 22, 2013

July FOMC minutes

The minutes of the July FOMC meeting indicate there was broad support amongst the committee members for the plan to initially taper their asset purchases program and end it altogether by the middle of next year.  However, there was no further elucidation of when that process might start or how quickly it would unfold.

As you know I’ve been less convinced than the average market expectation that the initial steps towards tapering will be taken in September.  The discussion in the minutes around the conditions for tapering didn’t change my mind.  I agree that US economic growth will likely be stronger in the second half than the first, but I don’t expect it to as strong as the current Fed forecasts indicate, in fact the Fed will most likely lower their 2013 growth forecasts in their next set of projections.  The key risk for me is that fiscal drag from lower government spending has further to play out.

I’ve also struggled with the continued expectation that recent low inflation readings would prove to be “transitory”.  There is no sign of that yet: core PCE inflation continues to trend lower.

Only the labour market appears close to meeting the conditionality.  The unemployment rate is now 7.4%, which is getting closer to the “vicinity of 7%” which is the condition for ending the program.  In another positive sign initial jobless claims continue to trend lower.   At the same time the Committee acknowledges the low participation rate and employment-to-population rate along with the high incidence of part-time work indicates that overall labour market conditions remain weak.

In summary the minutes were very balanced with appropriate acknowledgement of the risks to the expectation of stronger growth and inflation returning to 2%.  For me the labour market supports a “yes” to September tapering, inflation is a “no” and growth is a “maybe”.

That said, one way to end the market speculation and uncertainty is just to get on with it.  If that’s the case, I expect a very gradual tapering process to be outlined (e.g. a reduction of $10 billion per month) with continued conditionality around the performance of the labour market, growth and inflation.  I would also expect forward guidance to be amended to incorporate a lower unemployment rate (e.g. 6%) to reinforce it will be a long time before the Committee starts to raise interest rates.


Wednesday, August 21, 2013

The RBNZ and macro-prudential tools

After much consideration and consultation the RBNZ has opened its new macro-prudential tool box and, as was widely expected, restrictions on high loan-to-value ratio (LVR) lending have popped out.  The RBNZ has announced that lending to high LVR loans (over 80%) will be restricted to no more than 10% of new lending from October 1st.   That ratio has recently been traveling around 30% so this new restriction therefore constitutes a potentially significant reduction in the supply of credit to the housing market.

This action is primarily intended to preserve financial stability.  However the RBNZ is clearly anticipating this action will also act to slow demand and assist with their recent predicament that we have described as being between a rock (the high exchange rate) and a hard place (the strong housing market.  Indeed in its statement today the RBNZ essentially said that if it were not for its new LVR restrictions, interest rates would be higher now.

The RBNZ believes that LVRs will be more effective than the other macro-prudential tools at its disposal in constraining private sector credit growth in the housing sector.  That may well prove to be correct.  However, I continue to believe that if financial stability is the primary objective of deploying macro-prudential tools, then requiring banks to hold more capital via the use of a counter-cyclical capital buffer would be more effective in that aim.

The most effective tool in constraining credit growth is undoubtedly higher interest rates.   The problem for the RBNZ is that the broader economy hasn't, and still doesn't, warrant higher interest rates.  But we are moving closer to that point.  Economic growth is accelerating and is running faster than potential and the output gap is closing.  At the same time pricing intentions and inflation expectations are now rising.

A strong housing market was never enough by itself to warrant higher interest rates.  But given where growth is heading, where forward inflation indicators are pointing, and the amount of work the RBNZ will inevitably need to do, my concern is that while relying on LVR restrictions to do the job they won't act early enough on interest rates to contain the inevitably higher inflation.  That would mean an ultimately more aggressive tightening cycle than would be the case if they started the process in a more timely and gradual fashion.

The RBNZ is clearly concerned about the exchange rate and the impact that a tightening here will have in a world where we the only developed economy tightening.  The reality is that many things other than interest differentials impact on the exchange rate.  However to the extent they do matter, an early and gradual tightening that locks in a relatively low interest rate cycle (compared with the last cycle that saw the OCR peak at 8.25%) will likely have less impact on the exchange rate than a more aggressive tightening further down the track. 

Tuesday, August 20, 2013

US productivity and potential growth

The US Bureau of Labor Statistics recently released revised productivity and unit labour cost data on the back of the recent benchmark revisions to GDP.  The end result is a tweak higher in productivity growth over the history of the data. Labour productivity growth has average 2.3% per annum since 1966, slightly higher than the previously published rate of 2.2%.

More recently the data is in line with what we expected to see: weak labour productivity in the December quarter of 2012 and March quarter of 2013 is consistent with the low GDP growth we saw over those quarters.  Productivity growth recovered into the second quarter of the year growing at a seasonally adjusted annual rate of 0.9%, although the annual rate of growth remained at zero for the second consecutive quarter.  Unit labour costs rose 1.4% over the year which is not a level that would trouble the Fed.

 The data also provides insights into the subdued nature of the recovery in the US economy since the Great Recession and, perhaps more importantly, what needs to happen if we are to see a return to a higher potential rate of growth.

Labour productivity has averaged growth of around 1.8% since the start of the recovery in early 2009.  That’s lower than the long-term average and broadly consistent with our view of post-GFC potential US GDP growth of around 2%, lower than the 2.5%-3.0% in the years leading up to the GFC.

If potential growth is to move higher we need to see a move back to higher productivity growth.  I expect we will see some recovery over the remainder of this year as the impact of fiscal drag wanes, growth strengthens and employment growth remains modest.  But for longer term gains in productivity we need to see stronger business investment.  That investment needs to be of the “capital deepening” variety (an increase in capital intensity).  That’s why we have always said a move back to previous rates of potential GDP growth requires solid business investment and why we put particular emphasis on equipment and software investment.

The sustainability element of the equation comes via the fact that higher productivity will assist in keeping unit labour costs in check which will in turn keep inflation subdued.  With productivity expected to move higher and business surveys pointing to higher investment in the period ahead, that supports the case for a very benign US inflation environment for some time yet.

Thursday, August 15, 2013

Euro area out of recession

After six quarters of recession the Euro area posted 0.3% growth in the June 2013 quarter.  That was slightly ahead of market expectations of +0.2%.  Many of the larger economies came in stronger than expected, especially France which posted +0.5% growth in the quarter following six months of recession.  Recall earlier in the year France was the country in the Euro area we were becoming most concerned about.

Some of the growth in the quarter can be attributed to statistical “payback” following weather-related disruptions in the first quarter of the year.  This was most notable in Germany which posted 0.7% quarterly growth in Q2 following a flat first quarter of the year which had surprised on the downside.  We don’t get any breakdown of the GDP numbers with these early “flash” estimates although the statistical office (FSO) suggested the growth in the quarter was mainly due to domestic demand and that investment demand was particularly strong.

Most of the upside surprise in France came from a sharp improvement in private consumption while public consumption also grew over the quarter.  On the downside investment declined over the quarter, albeit at a slower pace than in the previous quarter.  As we’ve said about all the major developed economies a return to robust and sustainable growth needs investment, so until we see investment growing, an element of uncertainty remains about the future growth trajectory.  We are therefore still cautious about the outlook for France.

Other results saw the pace of recession moderate in Italy (-0.2% q/q in Q2), Spain (-0.1%) and the Netherlands (-0.2%).  But perhaps the biggest surprise of the day came in Portugal which posted 1.1% growth in the quarter.  In Greece the pace of recession moderated.  We only get annual data for Greece which showed a contraction of -4.6% in the year to June, an improvement (if that’s the right word?) on the -5.6% in the year to March.

Looking ahead we take this result as a confirmation of stabilisation in the Euro zone rather than anything more robust.  It appears weather disruptions have added some volatility into the growth numbers over the first half of the year.  Also we know fiscal austerity and private sector deleveraging still has further to run.  At the same time, however, the PMI data has improved (the composite index stood at 50.5 in July) and confidence levels are improving as financial conditions have stabilised.  All things considered I have +0.1% quarterly growth pencilled in for each of the September and December quarters.

Sunday, August 11, 2013

China data improves

Last week’s China PMI data tantalised with signs of economic stabilisation following the recent run of softer data.  That led to a sense of optimism about the July activity indicators that was not disappointed:  industrial production, exports, imports and fixed asset investment all surprised on the upside.

Export growth recovered to 5.1% y/y in July, up from the -3.1% in the year to June.  It has been difficult to read too much into the export growth numbers recently given the over-reporting of data earlier in the year.  We attributed the weakness in the June data to some of the unwinding of that distortion.  Also July 2012 was a weak period for export (and imports) so this latest result is off a low base.  That said, the data was a pleasant surprise and is consistent with stronger export orders in the latest official PMI data which is, in turn, consistent with the recent improvement in data in Europe, Japan and America.

Imports put in an even more robust recovery in July at 10.9% in y/y, up from -0.7% in June.  This recovery needs to be interpreted with a little more caution.  I think it’s a bit too early to attribute this recovery to recent policy measures to boost domestic demand, so I’ll put a good portion of this bounce down to month-on-month volatility.

Industrial production came in at 9.7% y/y in July, up from 8.9% in June.  As with the trade data, a part of this rebound must be attributed to base effects, but it’s still a damn good number.  Growth in fixed asset investment rose to 20.1% y/y in July, up from19.4 in June with strength coming through in infrastructure, real estate and manufacturing.  The strength in manufacturing was a surprise given the over-capacity in that sector which we think still has further to unwind.  It could be that the recent easing in credit conditions, at least compared to June, may have had some positive impact.  The only disappointment in the data was retail sales with year-on-year growth in real sales falling to 11.3% in July from 11.7% in June.

On the inflation front the annual CPI was unchanged at 2.7% in July.  Food prices blipped higher from 4.9% in June to 5.0% in July while non-food inflation was unchanged at 1.6%.  Annual PPI deflation moderated somewhat from -2.7% in June to -2.3% in July, again partly due to base effects.  Inflation certainly doesn’t preclude more aggressive monetary policy easing, although the better-than-expected activity data means the authorities appear likely to continue with the process of policy tweaks while focussing their efforts on structural and rebalancing reforms.

I’m always careful not to read too much into monthly data, especially in China.  However the fact much of this data is consistent with other data (such as the PMI) and with what is going on in the rest of the world (stronger growth in US, Japan, stability in Europe) I’m taking this as a sign of emerging stability following six months of disappointment and uncertainty on the trajectory of China growth.  I think it’s still a story of offsetting factors in the period ahead.  We expect stronger exports on the back of stronger external demand in the second half of the year, softer (manufacturing) fixed assets investment with retail sales, despite the latest result, sailing somewhere through the middle. 

Wednesday, August 7, 2013

NZ labour market data solid enough

The key element I was looking for in today’s June quarter Household Labour Force Survey (HLFS) data was some element of consolidation following the strong March quarter result.  In that sense I was pretty happy – employment rose 0.4% in the quarter following the large 1.7% increase in March.  And while the unemployment rate moved higher from 6.2% in March to 6.4% in June, a higher participation rate was the catalyst which is itself a sign of improving labour market conditions.

Regular readers will remember it was difficult to make sense of divergent employment data over 2012.  Employment growth between the HLFS, a survey of households, and the Quarterly Employment Survey, a survey of businesses, was contradictory.   In the March quarter, much of that gap closed with a hefty 1.7% increase in employment in the HLFS.  My concern today was that employment might give back some of the March quarter gain in June.  In fact employment put in a reasonably robust 0.4% gain, taking the annual rate of HLFS employment growth to 0.7% in June, up from 0.3% in the year to March.

A cursory glance at the unemployment rate suggests an element of the weakness in the data.  I take a different view.  Given the increase in employment over the quarter, the rise in the unemployment rate was driven by a blip higher in the participation rate.  I take that as another sign of improving labour market conditions.  A key challenge at this stage of the cycle is to encourage previously disenchanted folk who have previously dropped out of the labour market to opt back in.  That only happens when people think the chance of finding a job has improved.  That’s a good sign.

Wages were on the soft side.  The private sector ordinary time Labour Cost Index rose 0.4%.  This index is quality adjusted to make it more akin to a measure of unit labour costs.  The annual rate in that index has now dropped to 1.7%, a continuation of the downward trend of recent quarters.  The unadjusted index, an indicator of nominal wage growth, dropped back to an annual rate of 3.0% in June from 3.3% in March.  Of course with low inflation that indicates solid real wage growth. 

From the Reserve Bank's perspective what matters most is where the labour market and particilarly wage growth are heading.   In that respect we look to recent business confidence surveys and, more specifically, employment intentions which are generally positive.  That has us expecting continued employment growth which helps underpin our forecasts of stronger consumer spending in the period ahead and an eventual reversal of the downard trend in unit labour costs.

Monday, August 5, 2013

Good PMIs in China, but growth risks still biased to the downside

To the extent that one can rely on PMI data, the July readings for both the manufacturing and non-manufacturing PMIs are suggestive of some near-term stabilisation in China economic activity.  That bodes well for July activity data due for release from later this week.  However, tighter credit conditions indicate the risk to growth is still to the downside.

The official manufacturing PMI rose from 50.1 in June to 50.3 in July.  That was ahead of market expectations and defied recent declines in the more narrowly defined HSBC index.  The key sub-indices of production, new orders and employment all rose, albeit modestly.  The non-manufacturing PMI also rose, coming in at 54.1 for July following three months of declines that had taken the index down to 53.9 in June.  That particular index however needs to put in a more concerted effort if it is to break out of its recent trend decline.

The manufacturing result in particular suggests some stabilisation in activity.  The production index came in at 52.4, up from 52.0 in June.  That suggests some upside to growth in industrial production in July.  The latest IP reading was 8.9% for the year to June.  And while we think retail sales will improve in July, at least in nominal terms due to higher inflation, we think fixed asset investment will have drifted lower again.  In terms of exports, we expect growth to move higher from the disappointing -3.1% in June.

There are a couple of significant opposing forces for China growth in the second half of the year.  Tighter credit conditions suggest further downside in investment.  Manufacturing investment will remain especially weak given still high excess capacity; we think that story still has further to run.  On the upside, we think exports will be given a helping hand by stronger US and Japanese growth, and the expected stabilisation in activity in Europe in the second half of the year.  However, the recent strength in the RMB will be a constraining factor.

We believe the authorities will continue to “tweak” policy rather than deliver any aggressive stimulus.  Employment indices in both PMIs suggest some stability in the labour market; an important consideration for policy action.  And input price indices in both surveys also rose suggesting higher inflation, or at least slower PPI deflation, in the period ahead.  At this point I’m still happy with my calendar year GDP forecast of 7.6% although risks are still biased to the downside.

Sunday, August 4, 2013

US Jobs undershoot forecasts but unemployment rate drops

Despite uninspiring GDP data and jobs data undershooting expectations, it was a good week of data for validation of stronger GDP growth in the second half of the year.

One of the areas where GDP surprised on the upside was business investment.  That combined with a sharply higher manufacturing PMI suggests the business sector is in at least reasonably good heart.  Households, and therefore consumer spending, will likely benefit from the wealth effect of higher house prices with the Case-Schiller house price index up 12.2% in the year to May.   Furthermore, while jobs growth disappointed somewhat in July it was still relatively solid and real incomes continue to grow.

The PMI was a solid affirmation of the improving trend in the manufacturing sector.  The production index bolted higher to 65.0 in July.  That’s up from 53.4 in June and is the highest reading since May 2004.  The new orders index also rose sharply to 58.3 from 51.9.

The strength in the production index is a bit of a surprise given that the key sources of weak demand (notably global trade) are still in play.  But given our expectation of a pick-up in growth in the second half of the year we will take the recovery in the more forward-looking orders series as an endorsement of the view of an underlying improvement ahead, although we are trying not to read too much into the magnitude of the increase.

The other surprise was the strength in the employment index which rose sharply to 54.4 from 48.7.  That had led to some optimism that manufacturing jobs might surprise on the upside in the payrolls data, however that optimism was only partly satisfied.   A 6000 gain in payrolls in that sector was better than the last few months but was hardly spectacular.

The overall non-farm payrolls growth of 162k undershot average market expectations of around +190k.  That disappointment was compounded with downward revisions to the prior two months totalling 26k.  As expected business services and retail led the gains, but the tone was generally soft over all sectors.  Construction posted a 6000 drop, but that’s consistent with recent (weather-related) soft activity data and does not change our view of a continued trend improvement in that sector despite recent increases in mortgage interest rates.

Despite sequestration he Government sector continues to hold up well in terms of both activity and jobs.  In the GDP data the Government sector posted an only modest annualised 0.4% drop.  In the payrolls data the sector added 1000 jobs.  That makes me wonder how much of the impact of spending cuts is in the numbers or whether there’s more to come through in which case this sector could be a drag on the economy for a while longer.  Time will have to tell on that one.

Despite the payrolls job miss, the unemployment rate dipped lower to 7.4% from 7.6% in June on the back of stronger jobs growth in the household survey and blip lower in the participation rate.  I get all the good and valid reasons for a lower participation rate but I can’t help believing that part of the recent decline in the participation is cyclical and will tend to moderate further declines in the unemployment rate in the period ahead.

Average hourly earnings fell 0.1% in the month, but that’s not a surprise following the 0.4% increase in June.  The annual rate stands at 1.9% or around the trend of the last couple of years.  All measures of wage/income gains are running ahead of current low inflation indicating solid gains in real incomes.

All things considered it’s been a generally good week of data, supporting the contention of higher though still not robust growth ahead.  Following the GDP release and revisions incorporated in that data the Fed needs annualised growth of 3.2% in the second half of the year to get to the bottom end of its forecast range.  I think that’s a stretch with something in the order of 2.6% more likely.  However that still represents a trend improvement in economic activity which won’t derail their intention to reduce the pace of asset purchases in the months ahead.

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.