- The pace of US GDP growth in Q2 2016 was distinctly weaker than expected at 1.2% on an annualised basis (versus a forecast for 2.5%) after 0.8% in Q1 (revised down from 1.1%)
- Data for consumption was a bright spot in the report, posting, as expected, an annual gain of 4.2%
- The trend in private fixed investment fell 3.2% – the biggest fall in seven years
- Inventory reduction subtracted 1.2% from GDP
- There were extensive revisions to GDP data back four years. Stronger first quarters and weaker second quarters were the result of these revisions
The data for US GDP in the second quarter, published in late July, attracted considerable attention in financial markets, its announcement being combined with revisions to data as far back as the fourth quarter of 2012.
The weak headline number showing GDP growth in the second quarter of just 1.2% on an annualised basis had the effect of pushing back the market’s expectations of an interest rate rise by the Federal Reserve towards the middle of 2017. The probability of another rate hike in 2016, as priced by fed funds futures contracts, fell from around 50% in the week before the report to around 37% in the wake of the report’s publication.
Based on this GDP report, the average pace of growth in the first half of 2016 was just 1% weaker than the average rate of about 2% since the current US growth cycle began in 2009 (see exhibit 1 below). Nevertheless, the data contains some good news for the second half of 2016.
Exhibit 1: Growth continues to disappoint in first half of 2016
Source: Bureau of Economic Analysis, Bloomberg
The revisions (the initial release is followed by two rounds of revisions) published in the Q2 GDP report effectively rewrote the GDP growth profile of the US, showing lower growth of 0.9% and 0.8% for Q4 2015 and Q1 2016, respectively (see exhibit 2 below). An important factor in these lower numbers was the hit as companies shed inventories for five quarters in a row. Without the resulting drag of 1.2%, US GDP growth would have been at an above potential rate of 2.4% on an annualised basis in the second quarter of 2016.
Exhibit 2: Real GDP growth (saar%)
Consumption was the bright spot, rising 4.2% on an annualised basis in the second quarter. Gross private domestic investment again disappointed, falling at a rate of 9.7%, the third consecutive decline. This is a significant fall even if allowance is made for companies in the oil sector cutting back on equipment and inventories.
In our view the Q2 GDP data reflects a trough in US growth following the period of very weak oil prices at the start of 2016 (due to energy companies reducing spending and a knock-on effect in manufacturing).
More recent data, such as PMIs in the US suggest to us that the pace of growth is picking up – we expect higher growth in the second half of 2016, as headwinds fade from inventory shedding and the energy sector. Markets for new and existing housing are robust, with new home sales rising by 20 000 to 592 000 in June. This was accompanied by a decent upward trend in the Case-Shiller house price index for 20 cities, which was at 5.24% YoY in May after 5.44% YoY. Confidence rose in an ongoing improvement in non-farm payrolls as the data showed another healthy rise of 255 000 in July on top of the 292 000 increase in June.
The unemployment rate remained unchanged at 4.9% in July and average hourly weekly earnings growth remained at 2.6% YoY. It appears that companies are not afraid of hiring people, which in our view makes a strong argument to counter fears of a rising recession risk. However, the combination of weak growth and robust job creation might be a sign that trend growth is declining, so monitoring business investment will remain important. Nonetheless we think markets are currently overly complacent about the probability of a rate hike from the Fed in 2016. We anticipate a hike in the fed funds rate before this year is over.
In the week after this GDP report was published, Governor Powell of the Federal Reserve Board of Governors, acknowledged that he is increasingly worried about ‘the probability of an era of weaker growth, lower potential growth, for a longer period of time’, which would mean that Fed rates will ‘just have to be lower than I thought’ to achieve the Fed’s objectives. We expect the Fed to do more this year than markets are currently pricing. Nonetheless, we do share the view that rates will low for a prolonged time and in a historical context.
This article was written on 18 August 2016, in Amsterdam