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US economy not as strong as it seems

US flag on bar chart Concept of economic recovery with stock market down and up.

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The US Bureau of Economic Analysis released its third estimate for GDP growth in the December quarter, which came in at 6.9%. That was up from 2.3% in the September quarter, but excluding the large inventory impact, the growth rate falls to 1.6% in the final quarter of the year.

GDP growth estimates can be biased in a number of ways. One is that the growth rate for the full year is calculated by taking the change in GDP from the previous quarter to the current quarter and multiplying it by four to get a full year result. This means that any particular increase or decrease that is outside the norm is multiplied by four, even if the element that caused the fluctuation is unsustainable or is reversed in subsequent quarters.

Arguably the two best examples of this were the pandemic-driven second and third quarters of 2020. While most quarters’ GDP results are in the low single digits, the second quarter saw a 31.2% contraction in GDP versus a real contraction of around 8% sequentially, and the third quarter came in up 33.8%, or just over 8% quarter-over-quarter growth.

Inventory building distorted last quarter’s GDP growth rate

The most recent example is the final estimate for the December 2021 quarter’s GDP result. Businesses build or destock inventories every quarter. If the changes are large enough, even if they are reversed in the next quarter or two, that change can have a significant impact on the GDP calculation. The same can also be attributed to trade, but usually on a smaller scale than inventory.

Inventory fluctuations largely even out over the long term, but it may take a few quarters for them to level out. Prior to 2021, when inventory changes negatively impacted GDP growth by 1.4% or 140 basis points for the year, the annual impact of inventories since 2009 has ranged from negative 0.77% or 77 basis points in 2015 to positive 1 .13% or 113 basis points in 2009.

Over the course of 13 years, inventories negatively impacted GDP growth in 10 years and positively impacted the calculation only in three years.

The numbers below show the reported growth rate for each of the four quarters of 2021 and how it was after eliminating the impact of inventory and trade. If inventories are removed, the first half of the year shows the economy was stronger than reported and weaker in the second half.

Without inventory impact

  • Q1 2021: Reported 6.3%. Without 8.9%
  • Q2 2021: Reported 6.7%. None 8.0%
  • Q3 2021: Reported 2.3%. Without 0.1%
  • Q4 2021: Reported 6.9%. Without 1.6%

For traders, this turns out to have weighed on reported numbers in each of the four quarters. This is reflected in the numbers below, all of which are higher than the ex-inventory results above.

Without inventory and trading effect

  • Q1 2021: Reported 6.3%. Without 10.5%
  • Q2 2021: Reported 6.7%. Without 8.2%
  • Q3 2021: Reported 2.3%. Without 1.4%
  • Q4 2021: Reported 6.9%. Without 1.8%

To break down the fourth quarter GDP calculation into its various components, click on this tweet from Gregory Daco, Chief Economist at EY Parthenon.

The Atlanta Fed model puts GDP growth at 1.3% in the March quarter

The Federal Reserve Bank of Atlanta releases data and a chart estimating GDP growth rate for the current quarter. The GDPNow model shows growth of 1.3% for the March quarter compared to the blue-chip consensus range of 0.8% to 2.8%. Keep in mind that the blue chip estimates shown in the chart are almost a month old (there is a lag between the numbers in the chart and their current projections). This compares to the 2021 GDP growth rate of 5.7% and 5.3% excluding the impact of inventories.

Also, the Atlanta Fed’s GDPNow forecast is based on a formula from previous quarters, and the impact of Covid-19 could have a material impact on the estimate.

GDPNow GDP forecast of 1.3%

Federal Reserve Bank of Atlanta, blue chip economic indicators and blue chip financial forecasts

Jefferies economists remain ‘constructive on growth’

Jefferies Chief Economist Aneta Markowska and Jefferies Money Market Economist Thomas Simons publish a weekly report titled “Tracking the Reopening of the US Economy with Real-Time Data.” It is a compilation of various economic indicators that show how the economy is developing long before many official US government reports are produced.

The Jefferies US Economic Activity Index closed last week at 100.4, about 2 points above its level a month ago and almost 6 points above its Jan. 15 low. However, it is down over 10 points since its peak in late 2021.

Real-time data of the US economy

Jefferies

Markowska and Simons write in their latest report: “Our real-time activity index has held up well over the past few weeks. Almost all sectors saw modest improvements, with the notable exception of residential construction. This is the most interest-rate-sensitive sector of the economy, and judging by mortgage applications, recent hikes in mortgage rates are already weighing on demand for housing. However, this does not apply to other sectors of the economy. Most notably, consumer activity remains very resilient and has not shown any cracks so far. On the contrary, most real-time indicators of consumer spending are pointing to increasing upside potential in March, for both goods and services.”

They added: “There are many reasons to worry about the economic outlook: runaway inflation exacerbated by the invasion of Ukraine and the COVID outbreaks in China, strong interest rate hikes and a yield curve that is about to collapse reversal stands. Despite these headwinds, we remain very constructive on growth, arguing that household finances are strong enough to protect consumption (even at the lower end) from these shocks. So far, so good.”

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