Looking Back, Looking Ahead

Real GDP is now estimated to have risen at a 4.6% annual rate in 2Q14. However, the second quarter’s strength must be balanced against the first quarter’s weakness (a -2.1% pace). As the third quarter ends, we still don’t have a complete picture. However, figures are likely to suggest a moderately strong pace of growth and a gradual taking up of economic slack.

Consumer spending accounts for 70% of Gross Domestic Product. Inflation adjusted spending fell 0.2% in the initial estimate for July, following a 0.2% gain in June – suggesting very little positive momentum into the early part of 3Q14. Those figures will be subject to revision in this Monday’s report on personal income and spending. The August spending figures and September auto sales data will help to fill in the consumer picture for 3Q14. Motor vehicle sales snapped higher in August, which should drive overall spending up.

Weak growth in real average wages has been a restraining factor for consumer spending in recent months. Labor compensation has been rising roughly 2% year-over-year, vs. a normal pace of 3.5% to 4.0%. The average worker is barely keeping up with inflation. Lower gasoline prices ought to help in the remainder of the year. Retail gasoline prices normally fall about 12% between May and December. They’ve already fallen 8.7% this year. Spending less to fill their gas tanks, consumers should be left with more to spend on other things over the next few months. The 13-week average is good for gauging the lagged impact on consumer spending.

Business cycles are characterized by swings in capital expenditures. Business fixed investment rises in economic expansions and crashes in recessions. The aftermath of the tech bubble was large, but the pullback in investment in the financial crisis was a lot steeper. The monthly data on shipments and new orders tend to be choppy, but the three-month averages have shown a strong trend in recent months. Business fixed investment rose at 1.2% annual rate in the first quarter, but accelerated to a 9.7% pace in the second. Data for July and August suggest continued strength in the third quarter.

Capital expenditures are driven largely by profits, although businesses are not going to expand if they don’t think the demand will be there. Recent strength in capital spending suggests a renewed optimism regarding economic growth over the next several quarters. Note that firms have a tendency to hire new workers as they increase capital expenditures. Hence, good economic news could feed on itself.

Faster inventory growth added 1.4 percentage points to GDP growth in 2Q14 (vs. -1.2 ppt in 1Q14). While we have limited information at this point, inventory growth is likely to have slowed in 3Q14, subtracting from overall growth.

Global growth has been a lot weaker than expected this year. The dollar is a lot stronger. Hence, export growth ought to be restrained in the months ahead and imports (which have a negative sign in the GDP calculation) should be somewhat stronger. However, while foreign trade is likely to limit the overall pace of GDP growth in the next few quarters, domestic demand is likely to be significantly stronger.

Where does this put Federal Reserve policymakers? The key questions are how much slack remains in the economy and how rapidly that slack is being taken up. A low inflation environment allows the Fed more time to make these assessments.

© Raymond James

© Raymond James

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