Goldman Slashes Economic Forecast, Cuts Q3 GDP To 2.5%, Sees Q2 Below Stall Speed

Tyler Durden's picture

Nobody could have foreseen this now typical Friday night bomb from the 200 West macroeconomic wrecking crew. Nobody. Well... "Here is the first official Q3 GDP downgrade, courtesy of JPM's Michael
Feroli. We fully expect every other clueless Wall Street lemming to
follow suit in minutes." But as long as the lemmings all move in a herd over the cliff, they will still somehow all get paid the same $5 million (of which 25% is cash and the rest is indentured cliff-vesting equity servitude) at the end of the year. Either way, can we all now agree that Goldman did indeed jump the shark in December, especially now that it sees Q1 GDP at below stall speed in real terms. So here it is: "Following another week of weak economic data, we have cut our estimates for real GDP growth in the second and third quarter of 2011 to 1.5% and 2.5%, respectively, from 2% and 3.25%. Our forecasts for Q4 and 2012 are under review, but even excluding any further changes we now expect the unemployment rate to come down only modestly to 8¾% at the end of 2012." Here is why Hatzius gets paid the big Bernankebux: "The “bugbear” is that we are still unsure about the precise reasons
for the slowdown in 2011 to date, which is sharply at odds with our
expectation at the end of last year that growth would accelerate in
2011
." And the punchline: "Our forecast remains no fresh monetary easing from the Federal Reserve, but the probability has risen. In particular, Fed officials would undoubtedly ease if the economy returned to recession—not our forecast, but clearly a possibility given the recent numbers." Our prediction is that when Bill Dudley's 2011 calendar is released in December, his first meeting with Jan Hatzius at the Pound and Pence will have taken place right.... about.... now.

From GS:

More Downgrades to Our Growth Forecasts

  • Following another week of weak economic data, we have cut our estimates for real GDP growth in the second and third quarter of 2011 to 1.5% and 2.5%, respectively, from 2% and 3.25%. Our forecasts for Q4 and 2012 are under review, but even excluding any further changes we now expect the unemployment rate to come down only modestly to 8¾% at the end of 2012.
  • The main reason for the downgrade is that the high-frequency information on overall economic activity has continued to fall substantially short of our expectations. In particular, our “bean count” for second-quarter GDP has deteriorated further and our monthly Current Activity Indicator (CAI) is showing growth of just 1.3% in June.
  • Some of this weakness is undoubtedly related to temporary factors, namely supply chain disruptions and (the temporary part of) the oil shock. But the slowdown of recent months goes well beyond this. One major concern is the anemic growth in domestic final sales of just ½% (annualized) in the first half of 2011. There is only one precedent in the postwar period for such weak demand growth outside the immediate vicinity of a recession.
  • We have no hard information about final sales in Q3 yet, but Friday’s preliminary consumer sentiment index for July from the University of Michigan fell to the lowest level since March 2009 (!) and is now back in territory normally associated with recession.
  • Our forecast remains no fresh monetary easing from the Federal Reserve, but the probability has risen. In particular, Fed officials would undoubtedly ease if the economy returned to recession—not our forecast, but clearly a possibility given the recent numbers.

Following another week of weak economic data, we have cut our estimates for real GDP growth in the second and third quarter of 2011 to 1.5% and 2.5%, respectively, from 2% and 3.25%. Our forecasts for Q4 and 2012 are under review, but even excluding any further changes we now expect the unemployment rate to come down only modestly to 8¾% at the end of 2012.

The main reason for the downgrade is that the high-frequency information on overall economic activity has continued to fall substantially short of our expectations. In particular, our “bean count” for second-quarter GDP has deteriorated further and our monthly Current Activity Indicator (CAI)—a broader and higher-frequency measure that takes into account 25 different indicators of monthly and weekly activity—is showing growth of just 1.3% (annualized) in June, with a pattern of deceleration through the second quarter (see Exhibit 1).

Some of this weakness is undoubtedly related to the disruptions to the supply chain—specifically in the auto sector—following the East Japan earthquake. By our estimates, this disruption has subtracted around ½ percentage point from second-quarter GDP growth. We expect this hit to reverse fully in the next couple of months, and this could add ½ point to third-quarter GDP growth. Moreover, some of the hit from higher energy costs is probably also temporary, as crude prices are down on net over the past three months. But the slowdown of recent months goes well beyond what can be explained with these temporary effects.

One piece of fresh evidence comes from the New York Fed’s Empire State survey for July, which showed another sub-zero reading for both general business conditions and new orders (see Exhibit 2). And while the Empire State is still clearly in mid-cycle slowdown territory, final demand growth has slowed to a pace that is typically only seen in recessions. This is illustrated in Exhibit 3, which shows that real final sales to domestic purchasers—that is, real GDP excluding inventories and net exports—has grown at an estimated rate of only ½% (annualized) in the first half of 2011. There is only one precedent for such a weak demand growth pace outside the immediate vicinity of a recession.

One key question in coming months is whether final demand recovers to the 2%-2½% pace that is probably necessary to keep GDP growth near trend and prevent the unemployment rate from rising more noticeably. Obviously, we have no hard information about Q3 in this regard yet, but Friday’s preliminary consumer sentiment index for July from the University of Michigan was highly discouraging. The index fell to the lowest level since March 2009 (!) and is now back in territory normally associated with a contraction in real consumer spending and overall final demand (see Exhibit 4). Admittedly, consumer sentiment does not have much forward-looking value, and it is possible that the extensive media coverage of the negotiations around the federal debt ceiling has depressed sentiment. If so, agreement on this issue—which we believe may be coming closer—could lead to a rebound in sentiment. However, we would probably need to see a substantial improvement to undo the dramatic message of Exhibit 4, and to avert further downgrades to our GDP growth estimates in Q4 and 2012.

Unfortunately, our confidence in the growth forecast remains relatively low. The “bugbear” is that we are still unsure about the precise reasons for the slowdown in 2011 to date, which is sharply at odds with our expectation at the end of last year that growth would accelerate in 2011. Logically, the explanation presumably has to involve a combination of a) unforeseen shocks from the Japan earthquake and the oil market, coupled with b) more vulnerability to these shocks, because c) the housing and credit market downturn is weighing on private-sector balance sheets for even longer than we thought. But the relative importance of these issues is exceptionally difficult to sort out, and it makes a great deal of difference for the outlook.

The weaker data on economic activity have clearly raised the probability of renewed monetary easing by the Federal Reserve. In his monetary policy testimony this week, Chairman Bernanke’s main argument against renewed easing was that inflation is now significantly higher than it was in the summer of 2010. Indeed, the core CPI for June released on Friday showed a pickup in the 6-month annualized inflation rate to 2.5%, clearly above the “mandate-consistent” rate of 2% or a bit less. However, we may well have seen the highest inflation figures. Exhibit 5 shows that underneath the surface, both the “median” and “trimmed-mean” indexes—statistically based measures of underlying inflation that may be preferable to the better-known core CPI—showed a notable slowdown. Therefore, we still expect core inflation to slow substantially on a sequential basis over the next year.

Moreover, if the economy returns to recession—not our forecast, but clearly a possibility given the recent numbers—Fed officials would undoubtedly ease anew even if inflation is close to their target. Indeed, Chairman Bernanke laid out the possible options for such a move in his monetary policy testimony this week, namely a change in the forward-looking language in the FOMC statement, a cut in the interest rate on excess reserves, and—last but certainly not least—an increase in the size and/or composition of the Fed’s balance sheet.