US GDP Instant Reaction: The Tainted Core under Multiple Layers of the GDP Onion

Hopes were high heading into the release of today’s Q4 GDP report, and at first blush, the headline figure failed to live up to expectations. The first estimate of US economic growth came in at 2.6%, below economists’ anticipated reading of 3.0%. However, there is a lot more nuance “under the hood” of this complex report.

Peeling away the first layer of the onion reveals some potentially bullish news. The Personal Consumption component of GDP actually rose at a 4.3% rate, stronger than the 4.0% rise expected by traders and economists. In the US, consumer spending represents around 70% of the total economy, and strong growth in this critical sector is seen as more sustainable and “legitimate” than changes in other accounting-based measures like inventories.

That said, if we peel away the next layer of the GDP onion, it reveals a potentially tainted core, at least for Fed policy. In short, there is absolutely no evidence of accelerating price pressures: the GDP price index was flat quarter-over-quarter vs. expectations of 0.9% rise, while the broad employment cost index measure dropped to 0.6% from 0.7% last quarter. Because, the employment cost index measure takes into account benefits and other measures of compensation, it is more relevant than the monthly NFP reports average hourly earnings measure, but regardless of which measure is used, there’s no evidence that employee wages are rising, meaning that there’s no evidence of any inflation coming down the pipeline. Therefore, the lack of inflationary pressures makes it more likely the Fed will hold off longer before pulling the trigger on any rate hikes, despite today’s solid growth in consumer spending.

Market Reaction

The market reaction supports the dovish-Fed view: US 10yr bond yields are dropping to a new 20-month low under 1.70%, while the dollar is pulling back against most of its major rivals. As we noted on Wednesday, this report could finally lead to a breakout from USDJPY’s tight range: if support around 117.25 is broken, bears may look to target the 2.5-month lows around 116.00 next week.