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Robust U.S. GDP Report Shows Goldilocks Economy

31 Jan 07

Fourth-quarter U.S. GDP growth came in above expectations, at 3.5%. Consumer spending and exports were the key drivers of growth. Inflation indicators were benign. All in all, the report is a Goldilocks recipe that will keep the Fed on hold.

The advance estimate of fourth-quarter GDP growth came in at 3.5%, better than the 3.0% expected by consensus and Global Insight, and up from the 2.0% pace in the third quarter.

The overall 3.5% outcome was generated by a mixture of big positives and some big negatives. Overall domestic demand growth slowed, from 2.0% to 1.7%, but in effect the United States passed on the demand softness to the rest of the world, as imports declined. Meanwhile, the rest of the world propped up U.S. production growth through surging export demand. This is the reverse of the picture to which we have become accustomed—instead of the United States propping up the global economy, the rest of the world is now supporting U.S. growth.

GDP pluses and other good news:

  • Consumer spending accelerated to 4.4% growth, from 2.8% in the third quarter. The acceleration came in furniture and household equipment (helped by the boom in electronic items like flat-screen televisions) and food (eating out was probably boosted by sharply lower gasoline prices).
  • Foreign trade contributed a huge 1.6 percentage points to growth, as exports surged 10.0% while imports fell 3.2%. The last time that imports declined was in the first quarter of 2003, when the economy was struggling to get moving.
  • Government consumption rose 3.7%, contributing 0.7 percentage point to growth. Federal defense spending surged 11.9%.
  • The personal consumption price index fell 0.8% as gasoline prices plunged. This is the first quarterly decline in more than 45 years.
  • The core PCE index (watched closely by the Fed) rose 2.1% over the quarter and 2.3% over the past four quarters. This is still above the Fed's 1–2% comfort zone, but the trend is down. The quarterly figures are consistent with the December core PCE index (to be published Thursday, February 1) coming in at 2.2% year-on-year, the same as in November—although revisions to October and November could yet change the calculation.
  • Nonfarm business value added rose 4.2%. This is the output measure that feeds straight into productivity calculations, and points to an improvement in productivity growth (which was roughly zero in the third quarter) to around 2.0% in the fourth quarter.

GDP negatives and not-so-good news:

  • Residential construction declined at a 19.2% annual rate, an even steeper decline than in the third quarter. It knocked 1.2 percentage points off the overall GDP growth rate. Another decline is on the way for the first quarter.
  • Inventory accumulation slowed, subtracting 0.7 percentage point from growth. The inventory slowdown was overwhelmingly concentrated in the autos sector. Motor vehicle output fell at a 31.7% annual rate, as producers reduced their bloated inventories; auto output decline knocked 1.2 percentage points off GDP growth.
  • Real spending on business equipment and software declined at a 1.8% annual rate (mostly in industrial and transportation). This is the second decline in four quarters. Although equipment spending is volatile, the trend has slowed. Year-on-year growth was 9.2% in the first quarter of 2006, but 4.8% in the fourth.
  • Nonresidential structures growth slipped to 2.8%, from high double-digit rates in the second and third quarters. The December figures released shortly after the GDP report suggest that the 2.8% estimate is likely to be revised down next month.

The GDP news should make the Federal Reserve happy. Growth rebounded to a bit above its trend rate (which most analysts including Global Insight view as being around 3%), but at the same time the inflation news in the GDP report was benign. Productivity growth accelerated, which is good news for labor costs. What's more, the employment cost report, released at the same time as the GDP report, showed labor compensation increasing less rapidly than expected.

Will such robust growth be maintained in the first quarter? Probably not. Even though there are some signs of stabilization in housing, residential construction will again be a big drag in the first quarter, and it is hard to see foreign trade making such a strong contribution for a second quarter in a row. Government spending growth will probably be slower, as will consumer spending growth. On the plus side, the auto production drag will not be present, while nonresidential construction may bounce higher.

All in all, growth is likely to slip below 3.0% again in the first quarter (but not below 2.0%). That will be perfectly comfortable for the Fed, which wants to see core inflation decline further and sees "below-trend" growth as required to achieve that. Global Insight now expects GDP growth to come in at around 2.7% for 2007, and sees the Fed on hold deep into the year, perhaps all year.

by Nigel Gault

 
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