Temporary Boost from Fiscal Stimulus Package Accounts for Growth in 2008:Q2
Real gross domestic product of the U.S. economy grew at an annual rate of 1.9% in the second quarter, following a revised 0.9% increase in the first quarter. This report also contained revisions of GDP estimates going back to the first quarter of 2005.
Real GDP grew at a slightly slower pace during the period of revision (2005-2007, see chart 1). The most noteworthy aspect was the contraction in real GDP growth in the fourth quarter of 2007 (-0.2%) from an increase of 0.6% as per the previously published estimate.
In the second quarter, consumer spending grew at an annual rate of 1.5%, which is an improvement from the 0.9% increase in the first quarter. The fiscal stimulus package gave a boost to consumer spending in the second quarter. This being a one-off event implies that going forward consumer spending is most likely to show significant weakness in the absence of extra dollars from tax rebates. Of the three major components of consumer spending, purchases of durable goods are now down for two consecutive quarters. Outlays on non-durable goods picked up in the second quarter. Services, a relatively steady part of consumer spending, show the smallest gain (+1.8% on a year-to-year basis) since the first quarter of 2003.
Exports of goods and services grew at an annual rate of 9.2% in the second quarter, while imports fell 6.6%. The resultant sharp narrowing of the trade gap (-$395.2 billion vs. -$462.0 billion) was another big plus for the headline. Imports have declined for three straight quarters, which has helped to narrow the trade gap. The outstanding growth in exports may not be a repeat story because incoming data from trading partners of the U.S. has been weak, suggesting that less positive contributions from exports are likely in the quarters ahead.
The 3.4% jump in government expenditures compared with a 1.9% gain in the first quarter was another factor contributing to the growth of the economy. Residential investment expenditures fell at an annual rate of 15.6% in the second quarter, the smallest decline in the last four quarters (see chart 4). The second quarter reading of residential investment expenditures is encouraging to the degree that it suggests that the rate of decline for this component of GDP is moderating. However, actual growth in residential investment expenditures is several quarters away.
The 14.4% increase in outlays on structures was concentrated in activities related to the oil industry (mining and exploration moved at an annual rate of 30.6%) and manufacturing structures (+31%). The upward trend of oil prices has been the impetus to activity in the oil industry.
Weak economic conditions have brought about the decline in capital spending, with the 3.4% drop in the second quarter, marking the second consecutive quarterly decline. Given weak economic conditions in the near term, there is little reason to believe that capital spending will be the source of economic growth in the near term.
The reduction in inventories (-$62.2 billion vs. -$10.2 billion in Q1) was larger than the drop recorded in the first quarter (see chart 7). The bulk of the drop in inventories was in the factory sector. By comparison retail and wholesale inventories showed smaller declines. In an environment of weak demand conditions, firms should be unwilling to add to their stockpiles.
Essentially, economic growth has slowed over the past two years (see chart 8). We have gone down the laundry list of the different components of GDP and concluded that it is unlikely that any one sector can possibly give a lift to economic growth in the near term.
Price indexes indicate food and energy prices have raised overall inflation readings while the core is still above the implicit target of 2.0% year-to-year change.
It is nearly certain the Fed will leave the federal funds rate unchanged at the August 5 meeting. The market expects a higher federal funds rate at the end of the year. We do not. The details of the GDP report point to significant weakness in the economy. Against this backdrop and financial market fragility, the Fed would only exacerbate the economic situation by raising the federal funds rate in haste. Fighting inflation will have to remain on the back burner until financial and economic conditions improve. By that time, inflation is likely to be moderating as it is a lagging economic process.
Labor Market Reports: Employment Cost Index and Jobless Claims
The Employment Cost Index (ECI) moved up 0.7% in the second quarter, matching the gain seen in the first quarter. Wages and salaries increased 0.7% in the second quarter, one notch down from a 0.8% gain in the prior quarter. The increase in benefits (0.6%) during the second quarter was unchanged from the first quarter. On a year-to-year basis, the ECI advanced 3.1% vs. 3.3% in the first quarter. The main message is that labor compensation costs do not present an inflationary threat.
Initial jobless claims rose 44,000 to 448,000 during the week ended July 26, following substantial gains in the each of the prior two weeks. Continuing claims, which lag initial claims by one week, moved up 185,000 to 3.282 million.
The insured unemployment rate moved up to 2.5% from 2.3% in the prior week. A similar jump in the insured unemployment rate in one week last occurred in the week ended April 14, 2001. We remain skeptical of the size because these numbers are known to be revised in the subsequent week.
A new law extending the number of weeks that unemployed workers can collect unemployment benefits was seen as the reason for the sharp increase in jobless claims. According to the Labor Department, the impact of the new law will result in jobless claims being higher than normal for the next few weeks. The message here is that data distortions from a change in the law could be exaggerating the true trend, but the fact that workers are seeking accommodation under the new law is indicative of significantly weak labor market conditions.
