Trick Or Treat! Which Best Describes The First Read Of Q3 GDP?
What about the stronger-than-expected Q3 GDP report? The first read of Q3 GDP surprised to the upside, printing at 2.9%. This was better than the Street consensus estimate of 2.6% and the Atlanta Fed GDPNow estimate of 2.1%. It was also a big improvement from the Q2 reading of 1.4%. However, there were some potential anomalies/phenomena signs to consider.
- Exports of goods, most notably soybeans, was up 14.1%. This was helped by a generally weaker U.S. dollar for the first three-quarters of 2016, versus 2015. A stronger dollar could/should take the wind out of the export sails. It is believed that the strong export data added about one full percentage point (1.2%) to the GDP number and almost all of the export gain was due to the way soybean exports are accounted for in the GDP report.
- Orders for Non-Durable Goods contracted by 1.4%. This follows a gain of 5.7%, in Q2 2016. Since the beginning of 2015, Non-Durable Goods orders have printed in a range of 1.2% to 3.2%, until Q2 2016. Average Q2 and Q3 data and Non-Durable Goods orders were back in their recent range
- Inventory building, heading into the holiday season boosted GDP, but is unlikely to repeat in Q4 2016 and Q1 2017, when inventory runoff is more likely. All in all, inventory building, though stronger, was not as robust as typical Q3s of the past.
- Personal Consumption gains slowed from 4.3% to 2.1%. This is more indicative of Personal Consumption since 2015. I believe some of the 4.3% rise in Personal Consumption in the second-quarter of the year showed up in Durable Goods data in Q3.
U.S. Personal Consumption since 2015 (Bloomberg):
I believe Q3 2016 was a “catch-up” quarter rather than the start of a new trend. As a catch-up quarter, it is just “alright,” as recent history demonstrates.
U.S. GDP since 2010 (Bloomberg)
I do believe that the Q3 rebound does indicate that the U.S. economy remains on its 2.0% growth track. Just as those who saw doom and gloom in the first half of 2016 were proved wrong (I was not among them), I believe that those who are euphoric about today’s GDP print will also be proved incorrect. During the current earning season, many (if not most) CEOs of multinational corporations warned of slowing global growth. If correct, slowing global growth could slam the brakes on U.S. exports, particularly if the U.S. dollar remains strong.
At the time of this writing, during the hour following the GDP data release, the bond market did not react, much, to the data.The price of the benchmark UST note was unchanged to yield 1.85%, at the time of this writing, the morning of 10/28/16. If the bond market believed that Q3 GDP data was the harbinger of stronger growth and inflation, it should have made a run at 1.90%, given recent bond market trends. That it took the number in stride (and for what it was; moderately-positive) tells much about the bond market’s sentiment of the economy.
I believe that Stephen Stanley, chief economist at Amherst Pierpont Securities LLC in New York, summed it up well when he told Bloomberg News:
“The economy is good but not great. The economy is going to continue to rise and fall with the consumer, and the best news there is that the underlying fundamentals are strong.”
Bloomberg economists, Carl Riccadonna and Yelena Shulyatyeva summed the Q3 GDP report as follows:
“The 3Q GDP numbers are a positive signal that the economy’s brush with “stall speed” in the first half of the year did not take a turn for the worse. Nonetheless, after accounting for likely short-term contributions from inventories and net exports, the underlying trend hardly points to the “high pressure” economy Chair Janet Yellen recently advocated to address economic issues, such as low participation and sluggish productivity growth. This report fortifies policy makers’ inclination to raise rates in December, but it hardly suggests that they need to rethink their approach to 2017 and beyond.”
I hold similar views. This is why a return to a sub-1.50% (or even a sub 1.60%) 10-year UST note is not on my radar screen. However, a “good but not great” economy probably does not generate enough inflation to push the 10-year UST note above 2.00% or the 30-year U.S. government bond to 3.00%, at least not on a sustainable basis.
What about the inflation fears which are rampant among the punditry? Unless oil prices continue to surge, the year-over-year surge in inflation, due to the year-over-year increase in oil prices, should mostly disappear by the end of Q2 2017, after peaking in Q1 2017.
What about wage inflation? Following the GDP data, Deutsche Bank managing director and chief U.S. Economist, Joe LaVorgna, tweeted:
“Q3 #employment cost index is up 0.6% and just 2.3% over last 4 quarters. There is still scant evidence of meaningful labor cost pressure.”
Disturbingly, the media, including much of the financial medias, is reporting the 2.9% Q3 GDP report as indicative that the U.S. economy has shifted into a higher gear. It has not. Backing out the anomalies and the economy grew between 1.7% and 2.0%, in Q3. I guess we should never let the facts get in the way of a good story.
Disclaimer: The Bond Squad has over two decades of experience uncovering relative values in the fixed income markets. Let ...
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