The Economy Settles into Cruise Control
By Michael Englund
Steady as she goes: Despite big gyrations in the monthly U.S. economic data for May and June, the numbers have stabilized in support of Action Economics' estimate of 4% growth in second-quarter gross domestic product, due in a report July 30. That figure is within 0.1% of the two preceding quarters' growth rates. The ride hasn't seemed all that steady, but this is due largely to swings in perceptions rather than actual data.
The strong U.S. growth trend over the past several quarters may actually be in for a downward tweak. This would come in the annual revisions to the GDP numbers in the June 30 report, when data will be revised back to the beginning of the last recession in first quarter of 2001. In particular, the annual revisions should reveal downward trade adjustments through late 2003 and early 2004, given the last round of current account revisions.
This may take some luster off of the robust 8.2% growth rate previously reported for last year's third quarter. But at Action Economics we're not looking for any significant revision in the overall robust trajectory of U.S. GDP growth, despite the risk always associated with the annual revision process.
FOUR PRIME FACTORS.
More important, we expect a mix of second-quarter GDP data that will bode well for the third quarter and beyond, thereby leaving the markets looking at the prospect of continued strong growth over the quarters ahead. With some of the surprising declines in the June economic data, which now look likely to be reversed in July, GDP growth is likely to be even faster in the second half of the year than the first.
At the start of 2004, it seemed intuitive that the diminishing degree of fiscal and monetary stimulus through 2004 should lead to a similar GDP pattern. Yet, the monthly gyrations in U.S. economic data have disturbed that trend and produced a much different result: a notably flat growth trajectory over the past three quarters at almost exactly 4%, with a 5% gain now likely in the third quarter.
Of course, 1% variations in quarterly growth rates are no more statistically significant than the surprising stability of the past three quarters. The more important takeaway from recent U.S. GDP data is the surprisingly solid underlying growth trend. This is due to four key factors: aggressive consumer spending led by highly stimulative fiscal and monetary policies; business investment in the early stages of a solid rebound; a consistently robust housing sector; and a steady structural improvement in international trade, despite rising nominal current- account deficits.
CONSUMERS KEEP SPENDING.
All of these features of the current expansion should remain evident in the second-quarter GDP data to varying degrees. The least impressive data report will be for the consumer sector, where we expect only a 1.5% to 2% growth rate for real (adjusted for inflation) personal consumption. Yet, this modest real-growth rate largely will be due to another hefty gain in the report's key price gauge, the chain-price measure for personal consumption expenditures (PCE), that we estimate at 3.3%. This follows a big 3.2% first-quarter growth rate.
Nominal-spending growth remained solid in the first half, as consumers sustained their relatively low savings rate of 2.1% to 2.6% in each month, hence passing through their disposable-income growth directly to spending. This should continue in the third quarter, but as price growth moderates, the "real" growth rates should again rise.
Beyond the consumer, second-quarter data will look solid. Business fixed investment should post 10% real growth in the second quarter, as the equipment sector continues a healthy recovery, while commercial construction finally has started a cyclical upturn. The equipment statistics are gyrating around a solid growth trend, despite a February and March surge and ensuing pullback in April and May that left economists guessing. The business-investment recovery is as real as the surging profit statistics, and this pattern clearly extended through the second quarter.
As for housing, the solid round of recent home-sales data make clear that a projected 7% real second-quarter growth rate will be followed by further gains in third quarter.
Finally, the trade data may have provided a hefty "head fake" for the second-quarter GDP outlook, even though the bigger surprise for the markets may have been the general zigzag in June's and July's U.S. economic reports. With trade, an ugly set of April data raised questions about the degree of structural improvement under way in U.S. trade, despite the ever-widening nominal deficits.
But with the May data, it's again clear that consumers are returning to a pattern previously established during 2003 of buying fewer imports "on the margin." Import growth has certainly outpaced domestic spending, but the degree to which it has done so is modest relative to past cycles, when imports have soared. As with other expansions, exports have grown rapidly in response to the global recovery.
The underlying trade improvement is leaving only a small $8 billion net export subtraction in store for second-quarter GDP, despite the solid domestic economy, alongside evidence of Europe's ongoing economic stagnation and slower growth for many major U.S. trading partners.
In total, the second-quarter GDP report will produce roughly the same headline as the first quarter, and the fourth quarter of last year. The data will solidify expectations of a sound U.S. GDP growth trajectory. The mix of data also provides clear evidence of a solid growth path that will remain in place for the foreseeable future.
Englund is chief economist for Action Economics