GDP Slowdown May Give Fed Pause
Second-quarter U.S. economic growth fell well short of expectations—and that may prompt the Federal Reserve to pause in its series of interest-rate hikes. U.S. gross domestic product for the quarter underperformed Action Economics' own forecast, with the Bureau of Labor Statistics reporting only a 2.5% rate of growth, vs. our forecast of 3.6%.
The underperformance of second-quarter GDP relative to our expectations was largely a function of a big miss fixed investment due to a shortfall in the volatile equipment and software component, which fell 1%. We had projected a 2.0% rise in investment with an 8% gain in equipment.
Also falling short of our assumptions were the inventory, trade, and government contributions. Inventories added $11.4 billion to GDP in the second quarter following the revised $2.3 billion subtraction in the first. Net exports added $9.5 billion following the flat contribution in the first quarter. Government spending rose 0.6%.
There were large back revisions to the trade data that will leave a better trajectory for the deficit than was previously the case. However, the second-quarter trade outlook included weaker assumptions for export growth through June, which worsened the second-quarter figures relative to the first quarter.
INFLATION STILL RISES.
Meanwhile, personal consumption was actually stronger than we had projected in the second quarter, thanks to lower consumption deflators than we had assumed. Consumer spending rose at a pace of 2.5%, from a revised 4.8% in the first quarter, with weakness led by a 0.5% decline in durable goods.
Looking at the component of the report that measures inflation, there is still some cause for concern. The chain price index rose at a 3.3% clip in the second quarter (median 3.4%), following a revised 3.3% pace in the first quarter. The personal consumption expenditure (PCE) chain price index surged at a 4.1% rate in the second quarter, following a 2% rate in the first. The core PCE deflator, a measure closely watched by Fed policymakers, climbed to 2.9%.
This report included benchmark revisions that lowered the real growth trajectory for the economy over the last three years to an average 3.2% pace from 3.5% previously. Business and government accounted for much of the downward revisions. Price indexes were revised slightly higher, however, with the average annual GDP price index now at a 2.7% pace, vs. 2.5%.
This report is good news for a market hoping for a Fed pause. Wall Street was clearly cheered by the release, as stocks moved higher and Treasury yields headed lower, with the yield on the benchmark 10-year note moving below 5%. The dollar slid against major currencies.
Fed funds futures, a trading vehicle for market pros to bet on future interest-rate moves, largely priced out a rate hike in August, knocking the risk for an 18th consecutive quarter-point tightening to the mid-20% area. Meanwhile, euro-dollar futures are seeing trades consistent with rate cuts next year.
We now look for the Fed to move to the sidelines at its Aug. 8 policy meeting, given the slower than expected second-quarter growth rate, even as inflation concerns persist. The burden of proof will now be on the July nonfarm payroll report, scheduled for release on Aug. 4, and the accompanying disposition of wages. But with our projections for a 140,000 rise in employment and a 0.2% rise in wages, we suspect the Fed will have sufficient cover to take a break from its tightening cycle.
Much of the recent commentary from Fed officials has pointed toward a sanguine view on inflation, so we don't think the price data in the second-quarter GDP report will have an overriding impact on the rate decision. Also, Wall Street's diminishing expectations for an August hike will give policymakers even more of a comfort zone to sit tight on rates if they wish.