US economy slows in Q4; inventory glut to remain a drag in 2016 Q1

FXStreet (Mumbai) - U.S. economic growth slowed down sharply in the fourth quarter with economy growing 0.7 per cent, lower than expected 0.8 per cent growth rate and much lower than the 2 per cent growth pace seen in the third quarter. Growth has been hit by rising inventory which to a loss of appetite to restock. This impacted overall factory activity. Strong dollar and weak global economic outlook hurt exporters. The economy grew at a 1.6 per cent pace excluding inventories and trade indicating the huge negative impact of the slowing down of manufacturing sector trade on GDP. The economic expansion stayed unchanged in 2015 at 2.4 per cent. The Federal Reserve acknowledged that growth "slowed late last year".

Inventory in Q4 was worth $68.6 billion. Though it was lower than the $85.5 billion inventory seen in the third quarter, it was more than economists had estimated and subtracted 0.45 percentage point from Q4 GDP growth. Today’s data indicates inventory will continue to be a drag on growth in Q1 of 2016.

Business spending on equipment fell 2.5 per cent rate in Q4 after having risen at a 9.9 per cent pace in the third quarter.
On the other hand strong dollar and weak global demand hurt exporters. The dollar increased 11 per cent against the currencies of the trading partners of the US since January 2014. The consequent drag on export led to the creation of a huge trade deficit which economists believe subtracted half a percentage point from GDP growth in the fourth quarter which subtracted 0.47 percentage point from the GDP.

On account of unexpected mild weather consumers spent less on winter apparels and also on heating oil which went on to further depress the already dismal price environment. Consumer spending is expected to come in at 2.2 per cent, down from 3 per cent increase seen in Q3. Given that consumer spending accounts for more than two-thirds of U.S. economic activity, the decline had a significantly large impact on the overall GDP. A price index that excludes food and energy costs rose 1.2 per cent, slower than the 1.4 per cent pace seen in the third quarter

Lower oil prices continued led to the decline in profit margins of energy firms that were compelled to reduce their capital spending budget. Oil prices have fallen 70 per cent from their peak in June 2014 and have hit multi year lows in the recent past. This affected investment in this sector. Spending on mining exploration, wells and shafts suffered a huge fall. It dropped at a 38.7 per cent rate after dropping at a 47.0 per cent pace in the third quarter. Overall in 2015, investment in mining exploration, wells and shafts fell 35 per cent, marking the largest drop since 1986.

However, some analysts would like to stay optimistic believing that the recovery chances are strong given the hurdles which have surfaced in the form of inventory glut and mild weather are temporary. They would like to believe that with strengthening of the labor market which will eventually raise wages, restrained house prices which can help to boost spending and gasoline prices around US$2 per gallon, it is only a matter of time before growth gets back on track.

The Fed justified December’s rate hike citing significant improvements seen in the economy. Fed Chair Yellen had noted "With the economy performing well and expected to continue to do so, the committee judges that a modest increase in the federal funds rate is appropriate." The Fed had also stated that will raise rates by 25 bps four times in 2016. Going by the current economic conditions it seems that the downside risks to rate projections are larger as compared to upside risks. The Fed therefore will likely not be able to raise rates four times in 2016. The broad belief in the market is that the Fed will hike rates twice next year. The Fed has not yet ruled out a hike in March but the current volatility in markets can be expected to push the hike to June this year.