What was it the Federal Reserve said about the economy in the minutes of the most recent FOMC meeting released on Wednesday? “Information received since the Fed policy committee met in June indicates that the labor market strengthened and that economic activity has been expanding at a moderate rate,” pointing to job gains and solid consumer spending?
Yeah, well, the initial GDP growth estimate for the second quarter of 2016 doesn’t quite jibe with the Federal Reserve’s modestly bullish assessment of the economy right now. Per the first (of three) calculations, the GDP only grew 1.2% in Q2, falling short of the expected pace of 2.5% GDP growth.
The $64,000 question: Should we panic?
GDP Growth Falls Short, But…
On a relative basis, the shortfall is inherently a red flag. Economists led investors to believe the economy was stronger than it really is, and having been handed a plateful of shock today, those investors could understandably feel panicked.
That’s not how things have worked in the real world for a while now though. In the real world, sadly, investors have largely become immune to surprisingly bad news, recognizing such forecasts mean little anymore.
As evidence to that end, stocks have barely budged today despite the disappointing GDP growth rate.
Perhaps of more interest — and perhaps more encouraging — regarding the diminutive GDP data for Q2, traders recognize that’s still better than the third and final Q1 GDP growth estimate of 0.8%, and better than Q4-2015’s 0.9% GDP growth rate. Sometimes the direction of progress is enough prop the equity market up, even if the pace is lackluster.
Or perhaps more than anything else, investors know this is another reason for the Fed to remain as dovish and accommodating as its policy mandates will allow it to be.
Translation: A rate hike just became a little less necessary, giving Janet Yellen a little more space and a little more time to hold off on such a measure. The cheap-money spigot continues to flow.
Hot Spots, Sore Spots
In its defense, the Federal Reserve wasn’t wrong to be compelled by a high degree of consumer spending last quarter, which drives about 2/3 of the U.S. economy. Individuals spent 4.2% more in the second quarter than they did a year ago. It’s just that weak business and government spending proved to be a major drag.
Specifically, lowered retail inventories shaved 1.2 percentage points off the GDP growth rate for the second quarter. A lack of government spending took another 0.2 percentage points off the growth pace, and was only equally offset by the 0.2 percentage points the trade of goods added to the tally. Nonresidential business spending fell 2.2%, mostly thanks to oil companies continuing to curtail their unneeded production capacity.
Looking Ahead
While the first reading for Q2’s GDP pace came up short, bear in mind it will be revised two more times. It’s possible it could be adjusted higher, though it’s also possible it could be adjusted lower. Either way, the second and third calculations rarely dramatically change from the first look.
Be that as it may, though, one has to take it with a grain of salt, the Federal Reserve’s GDP growth outlook still calls for nominal progress going forward. The consensus estimate of the FOMC’s voting members, as of June’s pre-Brexit meeting, calls for a GDP growth rate of about 2% ever year (including this one) all the way past 2018.
Granted, this was the same Fed that was painting a relatively rosy picture just two days ago, seemingly overlooking just how weak business spending and investment was.
On the flipside, the Federal Reserve’s governors also have a clearer picture of how things progressed over the course of the quarter and understand the economic trajectory as of June. The GDP data weighs April’s data just like May’s and June’s, even though the economy may have taken a turn for the better in that span.
That being said, there is one immediate upside to the fallout of the tepid GDP reading for Q2. That is, the presumed suppression of interest rates has sent the value of the U.S. dollar down by more than a full percentage point, thus sending the price of crude oil higher.
A weaker dollar also helps U.S. multinational companies drive more overseas sales. Those two headwinds are a huge part of the reason corporate profitability has been unimpressive of late.
In that light, a merely modest GDP level may bring about more upside than downside.
Bottom line? Embrace the clues, but don’t sweat the numbers. Consumers are more than doing their part, and the energy sector remains the weak link, almost single-handedly crimping business investment.
The economy can survive that condition, even if it doesn’t sprint forward.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.
