Fed may Still Have to Revise Down its Growth Forecasts
Boosted by better net exports and greater inventory accumulation, Q2 US GDP was revised higher to 2.5% from 1.7%. This, coupled with a decline in weekly jobless claims, has kept the dollar bid. The data and the seemingly less imminence of strike on Syria have lifted US interest rates.
The US economy has regained some momentum after being hit with several shocks starting with the Super Storm Sandy in Q4 12 and the fiscal morass at the start of the year, that included, among other things, the end of the payroll saving holiday. The economy had nearly ground to a halt in Q4 12, expanding at annualized pace of about 0.1%.
It was at the end of Q3 12, it will be recalled that the Fed announced an open-ended purchases of MBS securities. At the end of Q4 12, the Fed rolled the $45 bln of monthly Treasury purchases, contained in Operation Twist, into QE3+ for a total of $85 bln a month in long-term asset purchases. Economic activity expanded by 1.1% in the first quarter and more than doubled to 2.5% in Q2 13.
While economic activity counts in the absolute sense, it is also important relative to expectations. The key expectations, in terms of policy, are not those of investors, but the Federal Reserve. The upward revision to Q2 growth is not sufficient to meet the Fed's 2013 expectations. Consider that in H1 the US economy expanded by roughly 1.8% at an annualized pace.
The Fed's forecast is for 2.3%-2.6% for the year. To achieve this, the US economy needs to grow by 2.8%-3.5% in H2, which seems unlikely. The market consensus, according to Bloomberg, is for the growth in H2 to be around 2.4%-2.5%.
This is important because of widespread expectations that the Fed will announce a reduction of its asset purchases next month. The minutes from the July FOMC meeting showed that the Fed's staff will less optimistic about its economic forecasts, but still expected the economy to accelerate in H2.
Could the Fed shave its growth forecasts, recognize that core PCE has shown little progress toward its target (and indeed closer to 0 than 2%) and taper at the same time ?
Meanwhile, the two sectors of the economy that are seen as particularly interest rate sensitive, autos and housing are vulnerable to the backing up of interest rates. There is some preliminary evidence that this is the case in the housing market.
A missile attack on Syria, even if just a shot across the bow, as Obama suggested (whatever that really means besides no use of ground forces), it appears to have knock-on effects on the looming debt ceiling. Previously, it seemed that some time in November it would be reached. This week Treasury Secretary Lew hinted that it could come a few weeks earlier.
Separately, we note that the revision to Q2 GDP also contained the first look at Q2 profits. The 3.9% rise (pre-tax) on a seasonally adjusted quarterly rate, which is the best showing since Q4 11. While it offsets the 1.3% decline posted in Q1, the fact that the year-over-year increase is a modest 5% is less inspiring. The increased pre-tax profits do not mean greater investment or accelerated employment. Corporate America has been cash rich. That is not the main obstacle. Indeed as we have shown previously, profits and investment in the US have become inversely correlated.
Lastly, while the US dollar has extended its earlier gains, we note that the two currencies that often do better on positive US economic news, the Canadian dollar and Mexican peso are still trading heavily. We often find the 5- and 20-day moving averages helpful in discerning the underlying trend. The euro and sterling's 5-day averages are poised to cross below the 20-day averages tomorrow or Monday. The Dollar Index's averages are crossing today.
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