A "Faith-Based" Forecast
By Michael Englund
Though most economists expect an acceleration in U.S. economic activity in the second half of the year, it's worth noting that the rebound is still a "faith-based" forecast given the sluggish economic data figures for for June. The trajectory of most of the economic data for the past two months suggest little rebound from the nearly-flat growth in gross domestic product (GDP) estimated for the second quarter as a whole.
Standard & Poor's MMS continues to expect GDP growth to accelerate to the 2.5% area in the third quarter, as unsustainable weakness in several of GDP components in the second quarter is reversed. But until the monthly data confirm this pattern, the risk is that growth will remain sluggish through the current quarter.
The rebound in U.S. GDP growth projected by most for the third quarter is due to three factors. First, tax rebate checks in ten $3.8 billion weekly installments will begin on July 20, and this should provide support for the already-resilient consumer sector. The rebates should provide a 0.5% boost to disposable income growth in July and a further 1.8% contribution in August, before unwinding in September, October and November. Second, the $25 billion pace of inventory liquidation in the first quarter, which will likely be followed by further liquidation of $5-$20 billion in the second quarter, is not likely to be sustained much longer as inventory-to-sales (I/S) ratios likely turned the corner around May/June.
And finally, exports and commercial construction will exhibit sharp declines in the second quarter that are unlikely to be repeated in the third, and are typical of the oscillating quarterly swings in these volatile components.
It's not particularly alarming that signs of the rebound are absent through June, as none of these three factors should have been expected to kick in before the third quarter. The rebate checks were only passed into law in the middle of the second quarter, and history does not suggest that "preemptive" spending of rebate checks is typical. The more likely pattern is impulse-spending of about one third of the distribution with a one or two week lag, followed by more deliberate spending or saving for the remaining portion. Given the highly-progressive nature of the rebate program, the impulse effect might beat expectations, but pre-emptive spending remains unlikely.
STOCKING UP AGAIN.
The magnitude of the inventory cycle in the current slowdown has been more dramatic than most had expected, but the duration is typical and the turn in I/S ratios seems imminent. The ratio has been plummeting for the retail sector since a December peak, as consumers continue to defy economic gravity and surprise retailers, and the ratio has finally reversed course for factories in May following a series of sharp sales declines in the first four months of the year that left the I/S ratio rising despite hefty inventory trimming. We believe the ratio for wholesalers peaked in May, leaving a downward trajectory likely for the second-half that will help fuel a return to inventory re-stocking.
Finally, the sharp respective declines of 12% and 17% that MMS expects for real exports and commercial construction in the second quarter are unlikely to be repeated in the third, thus removing another drag from second-quarter growth. The export drop in the second quarter is troublesome given growing signs of economic weakness abroad, but the figures seem excessive. For commercial construction, the sector is more clearly exhibiting sharp but unsustainable swings.
In total, the rebound in GDP growth does indeed appear imminent in the third quarter. But since we have yet to see confirmation of accelerating growth in the reported economic data, there is notable downside risk to the outlook.
Englund is Chief Market Economist for Standard & Poor's