Q1 GDP Preview
In just about an hour, the first (of three) Q1 GDP numbers will be released. It is expected to rebound to 3% from 0.4% in Q4. As Goldman explains, the bounce is expected to reflect "a mix of temporary factors -- namely a large inventory boost contributing about 1pp to growth -- and a genuine upside surprise from the strength of consumer spending despite the 2013 tax hikes." However, as we have since seen, the consumer "spending" was largely a seasonal revision of unadjusted data, which hardly was as euphoric, and which has sharply rolled over in Q2, meaning that what consumers add to Q1 GDP will be promptly removed from the second quarter. Furthermore, since there are two more GDP revisions, and since the Fed will likely seek to moderate QE "tapering" expectations, it wouldn't be surprising for GDP to come substantially weaker than expected, only to be revised higher (or lower) subsequently. In either case, for those who still believe macroeconomic fundamental data is relevant (in the New Normal it isn't), here is a quick run through what to expect from GS.
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GDP Preview, From Goldman Sachs
- Friday's first-quarter GDP report is likely to look strong on the surface, with real GDP growth of about 3.2% surpassing consensus expectations and PCE inflation well below the FOMC's target at around 1.2%. The strong Q1 growth rate reflects a mix of temporary factors -- namely a large inventory boost contributing about 1pp to growth -- and a genuine upside surprise from the strength of consumer spending despite the 2013 tax hikes.
- Despite the strong Q1, we expect growth to slow in Q2 as the boost from temporary factors fades and the drag from the sequester hits. We forecast GDP growth of 2.0% (annualized) in Q2 and Q3 and 2.5% in Q4. A downside risk to our forecast is consumer spending, which showed signs in March of a delayed impact of the tax increases.
- GDP has historically been one of the economic releases with the largest impact on bond and equity markets. However, since the start of the crisis most economic data have had a much larger market impact, while the effect of GDP surprises has faded. This could reflect both the growing popularity of alternative measures of aggregate economic activity and increasing attention to earlier releases that contain much of the data in the GDP report.
The first-quarter GDP report (to be released on Friday at 8:30am) is likely to show strong growth at a higher-than-consensus rate of about 3.2% and subdued headline and core PCE inflation of about 1.2%, in line with expectations and well below the FOMC's 2% target.
The strong first quarter reflects a mix of temporary factors and genuine upside surprises relative to expectations at the start of the quarter. The most important temporary contribution will come from inventories, which we estimate contributed about 1pp to growth in Q1 after a very weak 2012Q4. The largest upside surprise is consumer spending, which we estimate contributed about 1.8pp despite the 2013 tax hikes.
Exhibit 1 shows our estimates in detail. Residential investment continued to be the strongest sector in Q1 and we expect growth to continue at a rate of about 15% for the remainder of the year. Business investment slowed in Q1 after a very strong 2012Q4, but we expect strong growth to resume for the rest of the year and through 2014. Finally, while federal government spending was not a major drag on growth in Q1, it will be a large drag on growth for the rest of the year.
Exhibit 1: Breakdown of our First Quarter GDP Estimates
Despite the strong Q1, we forecast GDP growth of 2.0% (annualized) in Q2 and Q3 and 2.5% in Q4. This slowdown reflects both the fading of temporary boosts in Q1 and the impact of the sequester. A downside risk to our forecast is consumer spending, which we noted has recently shown signs of long-anticipated weakness. We currently expect spending to increase 2.0% (annualized) for each of the next three quarters, but a delayed impact from the tax hikes could push the growth rate of consumption down to the 1-2% range.
Much of the information contained in the GDP report is released in other, earlier reports. This might lead one to think that the GDP report has relatively little market impact because it contains only a modest amount of new information and is reported with a long lag. However, in previous research we found that a 1 standard deviation GDP surprise -- defined as the difference between the actual reported value and the Bloomberg consensus -- historically had the second largest impact on both equities and 10-year Treasuries of any data release over the period since 2003, led only by payrolls. Exhibit 2 compares the impact of surprises to GDP and other leading economic data releases. We again estimate the market impact of a surprise by measuring price changes during a 20-minute window surrounding the data release. While non-farm payrolls leads all other indicators by a considerable margin, the GDP report is second, ahead of other indicators that are released with much shorter lags. The chart suggests that a 1 standard deviation positive GDP surprise is associated with a roughly 2 basis point increase in 10-year Treasury yields and a 0.25% increase in S&P 500 futures.
Exhibit 2: GDP Has Been Among the Indicators with the Largest Market Impact
Recently, however, the relative market importance of GDP seems to have declined. Exhibit 3 compares the market impact of GDP with an average of five other economic releases that have a very large market impact, non-farm payrolls, the ISM manufacturing survey, the household employment report, the ADP jobs report, and retail sales. We compare the estimated impact during two five-year periods, 2003-2008 and 2008-2013. As we have noted before, the market response to most macroeconomic data has grown much stronger since the crisis, shown by the large increase in the estimated average impact of the group of top indicators. In contrast, the impact of GDP on equities has declined modestly. We also find a much starker change in the impact on bond yields, with the effect of a 1 standard deviation surprise falling from roughly 3bp to nearly zero.
Exhibit 3: Recently, the Market Impact of GDP Has Fallen
We see two potential explanations for the declining market impact of the GDP report. First, market participants have begun to pay more attention to alternative measures of aggregate economic activity, such as our Current Activity Indicator. Alternative measures have the advantages of being available in real time -- much more quickly than the GDP report -- and in some cases might be better at capturing momentum. Second, increased attention to the earlier reports that contain much of the information eventually included in the GDP report might have reduced its influence over time.