2012Q4 GDP and Federal Reserve Policy Announcement

Q4 Real GDP Contracts Slightly, Monetary Policy Stays on Course

  • Real Gross Domestic Product decreased slightly at a -0.1 percent annualized rate in 2012Q4.
  • The drag came from inventories and Federal defense spending.
  • Consumer spending, business fixed investment and residential investment were all good.
  • The Federal Reserve kept monetary policy unchanged from December.
  • The Fed funds rate remains tied to a 6.5 percent unemployment rate threshold. QE3 rolls on.
  • The January ADP Employment Report showed a gain of 192,000 private-sector jobs.

This morning’s 2012Q4 GDP report surprised on the downside as GDP contracted slightly at a -0.1 percent annualized rate. Several important points: (1) The media is over-reacting to the negative sign, (2) a -0.1 annualized growth rate is an even smaller negative on a quarter-to-quarter basis, not significantly different from zero, (3) inventories and federal defense spending were the big negatives, (4) consumer spending, business investment and residential investment were all good, (5) the inventory swing may have been an artifact of Hurricane Sandy, (6) the 15 percent  rate of decline in federal defense spending in 2012Q4 follows the unexpected +9.5 percent growth rate in defense spending in 2012Q3. Defense spending is gyrating and will continue to gyrate due to the likely impact of the federal spending sequester. The visuals are no doubt bad, but the details underlying the headline show ongoing moderate momentum in the private business and households sectors. HOWEVER, fiscal tightening matters! The downside risk of excessive fiscal tightening remains in place for the first two quarters of 2013. The subjective probability of recession remains at an uncomfortably high 40 percent through the first half of this year.

Today the Federal Open Market Committee kept monetary policy unchanged from the course set last December. The Fed funds rate will remain near zero as long as the unemployment rate remains above 6.5 percent and long-term inflation expectations remain below 2.5 percent. The Fed’s current program of asset purchases, known as QE3, will continue. There is no target date or condition for ending QE3. The consensus opinion is that QE3 will run through the remainder of this year, and may extend through early 2014 if the second half 2013 economic statistics are weak. The FOMC acknowledged a pause in 2012Q4 economic activity and blamed it on weather (Hurricane Sandy) and other transient factors. They were more positive on labor markets than in their December policy announcement, saying that employment continues to expand at a moderate pace. The FOMC also stated that strains in global financial markets have eased but downside risks remain. The January ADP jobs report showed a gain of 192,000 private-sector jobs for the month, consistent with our expectation of 180,000 payroll jobs from the official BLS report due out Friday morning.

Market Reaction: Equity markets fell after the Fed announcement. The 10-year Treasury bond yield climbed through the morning and then fell after the Fed announcement. NYMEX crude oil is up to $97.98/barrel. The dollar is up against the yen and down versus the euro.


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