Waiting for Escape Velocity
by Carl Tannenbaum and Asha Bangalore
Real gross domestic product (GDP) in the second quarter advanced 1.7%, which was better than expected. A downward revision of first-quarter GDP leaves growth in the first half at a tepid pace. However, trade and inventories data for June suggest that GDP growth in the second quarter stands to be revised upward slightly when the second estimate is published later this month.
The Bureau of Economic Analysis late last month published benchmark revisions going back to 1929 in addition to its first take on second-quarter GDP estimates. Comprehensive revisions take place about every five years. Intellectual property investment is the new category of capital introduced in these revisions. The new definition of GDP and the new source data raised GDP in 2012 by $550 billion. However, growth of real GDP in the recovery increased only 0.2 percentage points.
Incoming economic reports suggest that real GDP most likely will advance at a faster pace in the second half, with significant support from consumer spending and housing sector outlays and reduced fiscal drag. Strong self-sustained growth enough to propel the economy away from a modest ascent is probably getting closer as the recovery marches on for the fifth year.
Key Economic Indicators
Key elements of our forecast:
- July retail sales set a positive tone for consumer spending in the third quarter. The upward trend of equity and home prices, combined with the improvements in consumer sentiment measures, favor the growth of consumption. Auto sales slipped slightly to 15.8 million units in July, but the June-July average of 15.8 million units is still the best tally in nearly six years.
- Sales of existing homes slipped in June, but the three-month moving average continues to maintain an upward trend. Purchases of new homes moved up in June, putting the three-month average at the highest level in nearly five years. Lean inventories of unsold homes continue to prevail. The 100-basis-point increase in mortgage rates since the recent low is a source of concern, but it is not prohibitive.
- Home prices continue to post double-digit gains. This partly reflects the reduction in the share of distressed homes in the existing homes segment. Distressed properties made up 15% of existing home sales in June, the lowest reading since monthly tracking for this data series began in October 2008. As the number of foreclosed properties and short sales normalizes, the price picture should show a moderating trend.
- Residential investment expenditures are predicted to add to real GDP growth in the quarters ahead; a significant increase in this component is factored into our forecast for the rest of the year. While the share of residential investment expenditures in GDP rose to 3.1% in the second quarter, up from a low of 2.5% in the third quarter of 2010, there is still quite a distance to cover to match the historical mean of 5.8%.
- After benchmark revisions, business spending has two components: equipment and intellectual property products (includes software). Intellectual property investment is a relatively small and stable component of the U.S. economy. Incoming reports on equipment spending and the Institute of Supply Managements factory survey of orders bode positively for moderate growth in the near term.
- The much-feared negative impact from sequestration should be less of a setback in the second half of the year. The noticeable increase in exports in the second quarter could be an outlier, given the shaky economic status of the major U.S. trading partners.
- The Feds preferred inflation measure, the personal consumption expenditure price index, rose 1.3% from a year ago in June and relieved those members of the Federal Open Market Committee concerned about the decelerating trend of inflation. Inflation expectations have also moved up about 25 basis points since their low in June. Both of these factors point to a calm inflation picture for now.
- The June payroll employment gain of 162,000 was not the best, as it was lower than the previous three- and six-month averages. The decline of the jobless rate to 7.4% in July from 7.6% in the prior month is partly due to a lower participation rate. The mixed news from the labor market supports a December tapering announcement.
- Market volatility is nearly certain if Washington repeats last years clumsy handling of the debt ceiling issue. A smooth consideration of this matter is possible. Outside of this factor, risks from Europe and China remain in place. Although a few recent reports have reduced these risks somewhat, we are inclined to take the conservative stand.
- Interest rates have climbed since we last wrote our monthly update, largely due to improving economic conditions. A tapering of asset purchases is on the table, but the timing is unknown.