• Improvement. There is mounting evidence to suggest that the global economy is on the road to recovery. China has led the way and achieved the turnaround as far back as spring. According to our calculations, Chinese growth in the more informative qoq comparison was back in double digits. At the end of 2008, the trough was only close to 4%. The US is now following suit. For the current quarter, we expect real GDP to grow by 2½% annualized.

  • Setback. But there are also increasing signs that the recovery will be nothing more than a (technical) rebound. The upswing is not sustainable. Setbacks for leading & sentiment indicators are inevitable. The economy will lose traction again in 1H 2010. What the economy lacks is sustained impulses from final domestic demand. Markets have also adopted a more sober stance again after the "green shoots" euphoria in spring.

  • Retrospect. And when the US GDP numbers for the second quarter are released at the end of July, it should become clear just how severe the recession was. With -1½%, the US economy should have contracted for the fourth consecutive quarter – a new negative record! And with a cumulative 3½%, the contraction was the strongest in over 50 years. The GDP numbers will, however, also show that the recession softened considerably this spring (pages 2-5).

  • Components. The culprit responsible for the shrinking real GDP in 2Q is once again domestic demand. Personal consumption, residential investment and above all business fixed investment fell strongly. In contrast, above all net exports should have contributed to growth (cf. chart).

Real GDP

  • Further topics:

    – EMU: Oh (credit) bottom, where art thou (page 6)?

    – Data outlook: Ifo business climate to continue to point north; US leading indicators to post another strong gain (page 9).

    – Market outlook: Govies and EUR to move sideways (page 15).


Bad record: US economy shrank for four consecutive quarters!

  • Leading indicators suggest that a temporary recovery of the US economy will start soon. Moreover, we expect the official end of the recession will be dated as August or September.

  • In the past quarter, however, real GDP probably shrank another 1½%. For the first time ever, the US economy contracted for four consecutive quarters.

  • The culprit was once again weak domestic demand. Consumption and above all business fixed investment have fallen sharply, while net exports provided the only noticeable support for growth.

  • For the current quarter, we expect real GDP to expand by 2½%. But this is largely a technical recovery after one of the nastiest recessions in the US since WW II. What is missing for a self-sustaining upswing is above all the support of personal consumption.


For the second, third and.... fourth time!

At the end of the month, the Bureau of Economic Analysis will release its advance estimate for GDP growth in the second quarter. In this article, we are already venturing a forecast, and also discuss the growth contributions of the individual GDP components.

In recent weeks, we have stressed repeatedly that the severe US recession should end in the current half year. In the second quarter, however, real GDP probably contracted another 1½% per year. That would be the fourth consecutive decline – a series which is unprecedented since the beginning of the quarterly GDP statistics in 1947! Moreover, the US economy would have contracted by a total of 3½% since reaching the upper cyclical turning point in spring 2008. That would be the strongest decrease in real GDP in more than 50 years and, at the same time, the second largest decline since the end of World War II (see chart in the next column).

STRONGEST DECLINE IN OVER 50 YEARS

Real GDP


Domestic demand still very weak

The contraction in the past quarter was once again the result of weak domestic demand: We estimate that personal consumption, business fixed investment and residential investment combined shaved more than 3½ percentage points off growth. In contrast, government spending, private inventories, and above all net exports probably added slightly more than 2 percentage points (see chart).

GROWTH CONTRIBUTIONS IN THE SECOND QUARTER

Real GDP

Personal consumption probably contracted by an annualized 1% in the second quarter. This decline is, however, smaller than feared. Given the exceptionally weak labor market (since March non-farm payrolls fell by 1.3mn, while the unemployment rate rose to 9½% from 8½%) but also because of the solid increase in consumption of close to 1½% in the previous quarter, one could have easily expected a stronger decline in 2Q. But generous government transfers have more than offset the loss of labor income: While compensation of employees declined an annualized 1½% between February and May, disposable income increased by 12½% (see chart). On average for the months of April and May (the June report will not be released until the beginning of August), real consumption expenditures were “only” an annualized 0.5% below the 1Q level, as large declines in the consumption of consumer durables and non-durables were partly offset by higher demand for services.

GOVERNMENT TRANSFERS SUPPORT INCOME

Income

Business fixed investment also continued to decline strongly in the past quarter. After already slumping an annualized 30% between September and March, which is more than in any other 6M period since the end of World War II, we expect another 18% decline for the second quarter (see chart in the next column). Shipments of capital goods suggest that investment in equipment & software fell another 25%, but nonresidential investment (structures) might at the same time have posted a moderate increase of 5% – after plummeting by 42% in the preceding quarter.

UNPRECEDENTED SLUMP IN BUSINESS FIXED INVESTMENT

Business

Since the beginning of 2006, real residential investment has on average declined at an annualized 19½% per quarter (!) and shaved in each case close to one percentage point off real GDP growth. In the second quarter, the drag was probably even greater, as monthly numbers on construction spending point to a slump of 30%. That would be, after -38¾% at the beginning of the year, the strongest decline of the entire recession. As a result, the share of residential investment in GDP would decline to less than 2½%; at the beginning of the crisis just over three years ago, it was still 6¼% (see chart).

IMPORTANCE OF RESIDENTIAL INVESTMENT CONTINUES TO DECLINE

Relation

Government spending probably rose by roughly 3% in the second quarter, after posting an equally strong decline at the beginning of the year. High frequency data for the government sector are, however, rare, and given the fundamental situation, there are probably downside risks to our forecast. State & local governments, for example, undoubtedly had to curtail their spending further amid considerable financial problems. And while the federal government should have increased spending again after cutting the defense budget in 1Q, it must not be overlooked that the payouts for the stimulus program are mostly transfers to the private sector. And these do not show up as government expenditures in the GDP report but as personal or corporate spending.

In reaction to the slump in global demand, US businesses have tried to reduce costs dramatically. To this end, they eliminated 6½ million jobs since the beginning of the recession – and they slashed their inventories. In the first quarter alone, real inventories contracted at an annual rate of 5¼% (see chart), and for the second quarter we expect a similar decline. As the growth contribution of inventories is calculated as the change in the rate of change, private inventories should have had little impact on GDP growth in the past quarter.

RECESSIONS GENERALLY END WITH STRONG RESTOCKING

Real Inventories


Net exports support growth

The decline in GDP in the past quarter was only mitigated by a significant positive growth contribution of foreign trade. While real exports decreased by about 10% in 2Q, imports fell even stronger (-18%). As a result, the real trade deficit in May narrowed to the lowest level in close to ten years. According to our calculations, net exports added roughly 1½ percentage points to growth in the second quarter. It was therefore – once again – the growth engine of the US economy (see chart next column).

NET EXPORTS ARE THE GROWTH ENGINE

Continuation


Production points to downside risks

Our GDP forecast of -1½% for the second quarter is already more bearish than the consensus estimate (from June 8) of -½%. A glance at the production side of the economy does, however, reveal that even our estimate could be too optimistic. Indicators such as industrial production, aggregate working hours or the index of coincident indicators, which combines the four important time series production, employment, income and sales, were namely still clearly below the 1Q level. The deceleration in their pace of decline was not enough to indicate a GDP contraction of "only" 1½% or even ½%. Instead, these indicators point to a GDP decline of 2% to 2½% (see chart). If the production indicators were to prove correct, this would probably show up in a weaker inventory component, which then would have been a drag on growth again.

INDICATORS POINT TO A DECLINE OF 2%

Real GDP


Recession drawing to a close

The nasty economic recession in the US is drawing to a close. For the second half of the year, we expect real GDP to grow about 2¼%. That should be enough for the NBER’s Business Cycle Dating Committee to call the official cyclical turning point as August or September. One important area of strength in the short term will be, of all things, the car industry. According to Ward’s Auto, arguably the most important provider for analyses and data regarding the US car industry, US motor vehicle production is scheduled to rise to almost 6¾ million units annual rate in 3Q from about 4½ million in 2Q. According to our calculations, this production increase might add as much as 1½ percentage points to real GDP growth in 3Q (see chart). It will show up in higher consumption – additionally supported by the “cash for clunkers” program –, higher exports but also higher inventories. But even with this rebound, the level of auto production in 2H09 will remain 38% below the 2007 and 23% below the 2008 average, as motor vehicle assemblies fell for the last eight straight quarters due to lower demand and the bankruptcy filings of Chrysler and GM. This exemplifies that the temporary pick-up in GDP growth is primarily a technical rebound following one of the nastiest business recessions in the US since WW II. A lasting, self-sustaining recovery would require a solid pick-up in domestic final demand, particularly in private consumption. As household expenditures account for 70% of GDP, they generally played the decisive role in the upswing phases of past decades. Following the last three recessions (1981/82, 1990/91 and 2001), for example, private consumption expenditures contributed on average 2¾ percentage points to real GDP growth. This is roughly four times as much as the contribution of all other components combined. But with falling employment, lower real incomes and the end of the federal transfer programs, private consumption expenditures won’t be able to provide enough support for a strong, self-sustaining recovery this time. Therefore, we expect a W-shaped recovery.1 This means that the solid expansion in 2H will be followed by much more benign growth rates in early 2010. Against this backdrop, calls for a second stimulus program might become louder over the next couple of months.

Friday Notes