The recent brief uptick in economic high frequency indicators got you up? Feeling like suddenly the recession can be avoided because train traffic, whose sole goal is to stock up on even more soon to be liquidated inventory, hasn't yet collapsed? Happy by the beat in Non-farm payrolls, even though the beat was primarily a function of a one-time Verizon-strike boost, even as tax witholdings have hit an inflection point and are now declining? Amazed by the surge in car purchases, funded entirely by GM-targeted subprime loans issued by Uncle Sam, which have now declined for the first time in a year? Don't be silly, warns Goldman's Jan Hatzius, and presents a list why while the C-grade commentators out there may be caught off guard by the brief pick up in economic activity and proclaim the period of inverse economic growth over, it is all, quite, pardon the pun, "transitory."
Per Jan: 'Earlier this week we revised up our forecast for Q3 GDP growth to 2.5% from 2.0% previously, and incoming data have mostly surprised to the upside over the last month. However, we expect a slowdown to a ½%-1% GDP growth pace over the next two quarters." The reasons why: "First, despite stronger GDP, our Current Activity Indicator (CAI) shows growth of only 1.0% in September—better than August but still well below trend. This reflects recessionary levels in some survey-based measures like the Philadelphia Fed index, the NFIB small business index, and consumer confidence alongside the somewhat better employment, ISM, and housing data. Second, real income growth has stalled. Over the last year, real disposable personal income increased by just 0.3%. Except for a few brief dips in the past, real income growth this low has not occurred in the post-war period during expansions. Weak real income growth implies a challenging consumption outlook ahead. Third, recent data on consumer spending have been mixed. Vehicle sales have picked up, but this followed several months of weakness. The recent strength may therefore reflect a catch-up after supply-chain disruptions and not healthy consumer fundamentals. In addition, growth in non-auto consumer spending has slowed. Fourth, financial conditions have tightened sharply in recent months, and credit availability is probably deteriorating underneath the surface as the European crisis spills over into the US financial system." Of course, the one and only thing that really matters, a European implosion, leading to an acute global redepression, is not mentioned. With Dexia having about 24 hours left to live as a private company, it should be. That said, we would be remiss not to mention that the only purpose of Hatzius is to pave the path for the LSAP portfion of QE3. Be patient: what Goldman wants, Goldman always gets.
Earlier this week we revised up our forecast for Q3 GDP growth to 2.5% (annualized) from 2.0% previously. Several recent reports that feed into our “bean count” estimate of GDP—including durable goods shipments, manufacturing inventories and construction outlays—beat expectations in August. Indeed, incoming data have generally surprised to the upside over the last month. For instance, an index of our MAP scores recently turned positive for the first time since April (Exhibit 1).
Both the employment and ISM reports for September are also consistent with growth around the economy’s underlying 2½% trend. In particular, the September employment report beat expectations, with a 103,000 nonfarm payroll gain, a longer workweek, and a large gain in household employment. If sustained, this pace of payrolls gains is consistent with a roughly stable unemployment rate—far from good when the starting point is 9.1% but also not disastrous relative to the negative views prevailing in the financial markets.
Despite this modestly better news, we expect a deceleration to a clearly below-trend ½%-1% pace over the next two quarters, for the following reasons:
1. CAI signaling below-trend growth. After this morning’s employment report, our Current Activity Indicator (CAI) shows annualized growth of 1.0% for September, following an increase of 0.1% in August. This broad-based measure of real activity includes the main monthly “hard” indicators as well as the major survey-based data. While some indicators signal faster growth (e.g. vehicle sales) and others are consistent with slower growth (e.g. consumer confidence), the CAI as a whole paints a somewhat weaker picture than the “headline” GDP, employment, and ISM data.
2. Real income growth has stalled. Over the last year, real disposable personal income—household after-tax income, a key driver of consumer spending—increased by just 0.3%. Except for a few temporary spikes related to tax law changes and dividend payments in the past, real income growth this low has not occurred in the post-war period outside of recessions (Q1 2003 came close). Unless households lower savings rates further, robust consumption growth is unlikely with real income gains so slow.
As we noted in a recent US Daily, weak personal income growth also implies that real Gross Domestic Income (GDI)—an alternative measure of aggregate output to GDP—could be very soft in Q3. Today’s employment report helps a bit, and the estimate is sensitive to assumptions about profit growth. Still, assuming profit growth does not accelerate strongly, aggregate income growth is likely to be weak. If correct, real GDI would show a gradual deceleration in growth year to date, in contrast to the acceleration in the real GDP figures.
3. Consumer spending only mixed. Vehicle sales rose more than expected in September following four months of disappointing results, and the rebound in the auto sector is a major reason why we expect stronger consumer spending in Q3 than Q2.
However, we see a mixed message in the recent data on household consumption overall. For one thing, the vehicle sales results are less impressive in light of the weakness that preceded them. Exhibit 2 shows total light weight vehicle sales (to both households and businesses) and a trend line that represents the pace of recovery until this year. While vehicle sales recovered significantly last month, they remain below levels implied by the previous recovery path (about 13.5 million units as of September). Therefore, the recent strength in auto sales may simply reflect a catch-up in sales after supply-chain related disruptions, and may not be a positive signal about consumer fundamentals.
Besides, growth in non-auto consumer spending has slowed. Real personal consumption expenditures excluding motor vehicles increased at an annualized rate of 1.1% in the three months to August, down from 2.0-2.5% earlier this year. Real goods PCE excluding vehicles declined at an annualized rate of 0.7% in the three months to August (Exhibit 3). Similarly, although nominal retail sales have increased, adjusted for price change retail sales have actually fallen over the last three or six months.
4. Financial and lending conditions have worsened. Our GS Financial Conditions Index has tightened by about 75 basis points in the last three months as equity and credit valuations have come under pressure in the wake of the European crisis. In addition, credit availability has very likely deteriorated too. So far, the evidence for this is limited to an uptick in the August NFIB measure of whether “credit was harder to get last time,” as shown in Exhibit 4. However, we suspect that the next senior loan officers’ survey due the week after the November FOMC meeting will show some deterioration as well.
Overall the balance of data points to sluggish growth. In light of very low consumer confidence, tightening financial conditions and the ongoing financial crisis in Europe, we remain cautious about the near-term growth outlook.