Chief Economist Scott Brown discusses current economic conditions.
The Bureau of Economic Analysis will release its advance estimate of 2Q19 GDP growth on Friday. Consumer spending growth should rebound from a soft first quarter, while business fixed investment is expected to slow. Net exports and slower inventory growth are each expected to subtract from overall growth, but it’s unclear by how much. This release will include annual benchmark revisions covering the last five years, but that’s not expected to change the overall picture. Investors typically place far too much emphasis on the headline figure.
There’s a GDP report near the end of every month. First comes the advance estimate, which is based on incomplete source data for the quarter. That’s followed by the 2nd estimate, and then the 3rd, each incorporating a more complete picture. In the past, revisions have often been quite large, with the final estimate sometimes a full percentage point higher or lower than the initial estimate. However, these revisions have been unusually small in recent quarters. That likely reflects improvements in the collection of data.
Every summer, the BEA releases annual benchmark revisions, based on revision to the source data. About every five years, we get a comprehensive revision, based on definitional changes or methodology improvements. These typically result in changes to historical growth methods. We had a comprehensive revision in 2018. This year’s revision will be a garden-variety revisions. In the past, figures for the last three years were subject to revision. However, with this release and from now on, these revisions will cover the previous five years. According to the BEA, the longer time period will help to improve the seasonal adjustment of the data. In recent years, the first quarter GDP growth figures have tended to be below the average pace of the rest of the year, indicating some residual seasonality. Still, while this benchmark revision can be expected to shift growth a bit from one quarter to the next, it ought not to alter the overall picture of the last few years.
In economic terms, inventories are a stock ($), while GDP is a flow ($ per time). The change in inventories (a flow) contributes to the level of GDP. The change in the change in inventories contributes to GDP growth. In other words, if inventories are rising at a faster pace, that adds to GDP growth. If inventories are slowing, that subtracts from GDP growth. The pace of inventory growth has been brisk in the last few quarters. A slower pace should subtract from 2Q19 GDP growth.
Foreign trade is a part of GDP. Exports add to and imports subtract from the level of GDP. In a strong economy, we consume more imported goods, reducing GDP growth. In the first quarter, the trade deficit narrowed, which added to GDP growth. We’re still missing June trade figures, but it appears likely that the trade deficit widened in 2Q19, subtracting from overall growth.
Net exports and the change in inventories are relatively small parts of GDP, but they account for more than their fair share of quarterly volatility in GDP growth. Government spending can also be uneven, partly reflecting the timing of defense purchases. Private Domestic Final Purchases (PDFP) excludes government, net exports, and the change in inventories – equivalently, it is consumer spending plus business fixed investment plus residential fixed investment (the “meat and potatoes” of the economy) – and provides a better, less volatile measure of underlying domestic demand. In 1Q19, real GDP rose at a 3.1% annual rate, but PDFP rose at a 1.3% pace. We should see a strong reading for PDFP in 2Q19, but slower GDP growth.
Looking ahead, household fundamentals (jobs, wage growth) should continue to support a moderately strong pace of growth in consumer spending, which accounts for about 68% of GDP. Trade policy uncertainty and slower global growth have been negative factors for business fixed investment, which is likely to remain soft – but slower growth is not the same as contraction.
Data Recap – Retail sales results for June were better than expected, consistent with a rebound in consumer spending growth (following a weak
first quarter). Industrial production was flat last month, but manufacturing output picked up (although still in an overall downtrend in 2019). The Fed’s Beige Book was consistent with modest economic growth and limited upward pressure on inflation.
The Fed’s Beige Book noted that “economic activity continued to expand at a modest pace overall from mid-May through early July, with little change from the prior reporting period.” Sales of retail goods “increased slightly overall,” although vehicle sales were “flat.” Employment “grew at a modest pace.” Compensation rose at a “modest-to-moderate” pace, with “significant increases” in entry-level wages in some areas. Firms reported pressure from tariffs and labor costs, but “the ability to pass on cost increases to final prices was restrained by brisk competition.”
Retail Sales rose 0.4% in June (+3.4% y/y), more than expected. Ex-autos, sales rose by 0.4% (+3.3% y/y). Auto sales rose 0.7% (+4.1% y/y), a contrast to the slight decline in unit vehicle sales reported by the various automakers. Sales of building materials rose 0.5% (-2.5% y/y). Sales of gasoline fell 2.8% (-1.7% y/y), reflecting a 3.6% drop in gasoline prices. Ex-autos, building materials, and gasoline, sales rose 0.7% (+4.4% y/y), with upward revisions to April and May – an 8.0% annual rate in 2Q19, following +3.7% in 1Q19 and -0.3% in 4Q18.
Industrial Production was unchanged in June (+1.3% y/y), held back by a 3.6% decline in the output of utilities (-2.6% y/y). Mining output rose 0.2% (+8.7% y/y), with oil and gas well drilling up 0.5% (-6.0% y/y) and energy extraction up 0.9% (+13.1% y/y). Manufacturing output rose 0.4% (+0.5% y/y), led by a 2.9% gain in motor vehicles (+2.4% y/y). Vehicle production rose at a 4.9% annual rate in 2Q19 (vs. -14.9% in 1Q19). Ex-autos, factory output rose 0.2% (+0.2% y/y), a -2.8% annual rate in 2Q19 (vs. -0.7% in 1Q19).
Business Inventories rose 0.3% in May (+5.3% y/y). Retail inventories, the only new information in the report, rose 0.4% (autos +0.7%, ex-autos up 0.3%). Business sales (factory shipments plus wholesale and retail sales) rose 0.2% in May (+1.5% y/y).
Import Prices fell 0.9% in June (-2.0% y/y), partly reflecting a 6.2% drop in petroleum (-7.4% y/y). Ex-food & fuels, import prices fell 0.2% (-1.6% y/y). Prices of imported capital goods fell 0.2% (-1.3% y/y). Prices of imported autos and parts edged up 0.1% (-0.5% y/y). Prices of imported consumer goods ex-autos slipped 0.1% (-0.6% y/y). These figures do not reflect tariffs.
Building Permits fell 6.1%, to a 1.224 million seasonally adjusted annual rate (-6.6% y/y), reflecting the usual volatility in the multi-family sector. Single-family permits, the key figure in the report, edged up 0.4% (-4.7% y/y). Unadjusted single-family permits for 2Q19 were 5.0% lower than in 2Q18 (-7.7% in the Northeast, -4.6% in the Midwest, -6.4% in the South, and -6.1% in the West). Housing starts fell 0.9% (+6.2% y/y), also reflecting multi-family noise. Single-family starts rose 3.5% (-0.8% y/y).
Homebuilder Sentiment edged up to 65 in July, vs. 64 in June and 66 in May, reflecting a sharp rebound in the West.
The Index of Leading Economic Indicators fell 0.3% in June, a flat trend since September. Negative contributions were led in June by building permits (reflecting noise in the multi-family data), ISM New Orders, and jobless claims. Positive contributions were led by credit conditions, consumer expectations, the factory workweek, and the stock market.
The University of Michigan’s Consumer Sentiment Index edged down to 97.9 in the mid-July reading, vs. 98.2 in June and 100.0 in May. Evaluations of current conditions continued to improve, while expectations moved somewhat lower.
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