Q2 GDP Bounce-Back Confirmed, but Rapid Growth is Not Sustainable
The first estimate of Q2 real GDP growth exceeded expectations at 4.0 percent. Q2 GDP was boosted by an unsustainable surge in inventories, accounting for 1.7 percentage points of the 4.0 percent growth rate. Nominal inventories increased by $110 billion in Q2, after growing by just $40 billion in Q1. Theoretically, in a steady-state economy, inventories would not add much to GDP growth. However, this is not a steady-state economy. The components of GDP are still changing significantly on a quarter-to-quarter basis. The average nominal change in quarterly inventories since 2010Q1 has been about $62 billion. So it looks like inventory accumulation should ease going forward, pulling current quarter real GDP growth back down to earth, near 2.2 percent.
Another component of GDP, federal government spending, is also changing. Federal consumption and investment expenditures have been a drag on GDP for 13 out of the last 15 quarters, exacerbated by the Budget Control Act of 2011 which introduced the word “sequestration” to the economic lexicon. Federal discretionary spending for 2014 is projected to be just shy of $1.2 trillion, or $153 billion below the 2010 level. The drag from the spending sequester begins to ease in the second half of this year, supporting marginally stronger GDP growth going forward. That is not to say that the federal spending spigot is being opened wide. Rather, nominal federal discretionary spending is projected by the Congressional Budget Office to stay stuck near the 2014 level through 2017, and then begin to lift. Of course, by 2017 we will have a new President and spending priorities may change.
Payroll employment gains totaled 209,000 in July, marking the sixth consecutive month of +200K job growth. The unemployment rate ticked up inconsequentially to 6.2 percent and will likely resume its downward track very soon. The Employment Cost Index for 2014Q2 jumped by 0.7 percent, indicating that tightening labor markets may be starting to put some upward pressure on business costs. To be complete, the biggest push from the ECI recently has come from benefits. Wages and salaries were up by 1.8 percent for the year ending in June, while benefits were up 2.5 percent.
The Federal Reserve remains on track to end its active asset purchase program in October. Passive QE (the reinvestment of maturing assets) will continue to put downward pressure on the long-end of the yield curve well after the end of active QE. We look for interest rate liftoff in 2015Q2. Recent regulatory changes to money-market mutual funds may increase demand for Treasury bills, adding a buffering force to interest rate liftoff next year.
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