On the shock contraction in US GDP
US GDP contracted at a 0.1% annualised rate in Q4 of 2012 according to preliminary estimates announced by the US government earlier today. This contraction was well below consensus estimates and comes as a shock to most of the analyst community. Nonetheless, most macro analysts are not concerned because consumer spending in the US still seems to support continued recovery.
Real gross domestic product — the output of goods and services produced by labor and property located in the United States — decreased at an annual rate of 0.1 percent in the fourth quarter of 2012 (that is, from the third quarter to the fourth quarter), according to the “advance” estimate released by the Bureau of Economic Analysis. In the third quarter, real GDP increased 3.1 percent.
The Bureau emphasized that the fourth-quarter advance estimate released today is based on source data that are incomplete or subject to further revision by the source agency (see the box on page 4 and the “Comparisons of Revisions to GDP” on page 5). The “second” estimate for the fourth quarter, based on more complete data, will be released on February 28, 2013.
The decrease in real GDP in the fourth quarter primarily reflected negative contributions from private inventory investment, federal government spending, and exports that were partly offset by positive contributions from personal consumption expenditures (PCE), nonresidential fixed investment, and residential fixed investment. Imports, which are a subtraction in the calculation of GDP, decreased.
While the headline figure showed contraction, core numbers were just fine and the contraction was mainly due to three specific areas: private inventories (reduced GDP by 1.27%), federal government spending (reduced GDP 1.25%), and trade (reduced GDP 0.25%). The Federal number was mostly due to a shrinkage in defense spending. If one strips out the inventory and defense numbers, Q4 2012 GDP grew at an annualised 2.6% The question is whether these are one-offs or the beginning of something ominous.
Now, let’s remember that core personal consumption expenditures is humming along at a good clip, having risen 1.5%. Final sales in the private sector grew at an annualised 3.3% pace. That’s the fastest in at least 3 quarters. So I think this makes the case for the underlying fundamentals being strong. We should get confirmation that employment growth is adding to this via the jobs number on Friday. So, like most analysts I am not concerned because of this number.
What does concern me, however is that the numbers where we saw declines are the same places where we could expect to see declines if the sequester occurs, as I believe it will. Arguably, the dip in inventories was in reaction to the fiscal wrangling in Washington, meaning that businesses are taking precautions in case government cuts deeply. The defense spending contraction looks set to continue because the US Department of Defense is beginning to lay off up to 46,000 people in anticipation of the sequester. So that has already happened. Moreover, the payroll tax rise will hurt more than some anticipate because we know from Fed research that the payroll tax cut increased spending by a more than expected amount. If we add government spending cuts to this mix because of the sequester, I believe it will mean recession – something few are prepared for.