Weekly Commentary by Dr. Scott Brown
July 28 – August 1
The economic calendar is packed with important items this week. Oddly, Wednesday afternoon’s policy announcement from the Federal Open Market Committee may be the least interesting. One shouldn’t put too much weight on the advance GDP estimate, as the figures will be revised, but the initial estimate, along with annual benchmark revisions, should have important implications for the outlook for growth in the second half of the year. Payroll figures from the employment report are subject to a fair amount of statistical noise, but the financial markets will have to take the reported figures at face value.
The Federal Reserve has well telegraphed its intention to taper the monthly pace of asset purchases by another $10 billion. However, Fed officials are not expected to provide any fresh clues on exactly when short-term interest rates will begin to rise. Fed officials are researching and debating the mechanics of policy normalization (the tools and the order of steps to be taken as the Fed begins to remove policy accommodation), but won’t provide details in the near term. There may be some minor changes in the wording of the Fed’s economic outlook.
There’s nothing magical about the size of the Fed’s balance sheet. By itself, a large balance sheet does not imply a higher inflation rate. It’s a question of loan growth and whether that’s leading to inflation pressure in resource markets. When appropriate, the Fed can drain bank reserves through reverse overnight repos, issuing time deposits to depository institutions, or by raising the interest rate that the Fed pays on excess reserves held at the Fed (IOER). There are a number of issues regarding the ability of the Fed to take these steps in sufficient size, but officials are working on the details and expect to let the public know their conclusions by the end of the year.
The advance estimate of GDP growth is always an adventure. The government does not have a complete picture for the quarter and has to make assumptions about foreign trade, inventories, and other components. The GDP figure will be revised in late August and again in late September. Compounding the uncertainty this time, the government will also release annual benchmark revisions to the GDP figures for the last few years. This will be a “garden-variety” benchmark, one based on revised source data rather than any major change in methodology (although figures will incorporate the recently improved international transactions data). Typically, this kind of revision will shift some GDP from one quarter to the next, but not raise or lower the level of activity by much. Nevertheless, it will be interesting to see how much of the reported plunge in 1Q14 GDP holds up in revision. The PCE Price Index, the Fed’s chief inflation gauge, will be subject to revisions, but the recent history is unlikely to change by much.
Investors are likely to focus on the headline GDP figure, but the more important issue is what the data suggest about GDP growth in the second half of the year. Monthly figures on personal income and spending will be released on Friday, including benchmark revisions. Most likely, the recent figures will be consistent with many of the other major economic reports such as retail sales and industrial production. These reports showed a relatively strong rebound from the first quarter’s weather-related weakness, but with some loss of momentum heading toward the third quarter. That apparent loss of momentum is worrisome, as it suggests that second half GDP growth may be softer than was hoped for earlier.
Income inequality has been a political issue this year and the debate has largely focused on taxes. However, the more important concern should have been the whittling away of the middle class. Inflation-adjusted average wage income has been essentially flat. Last week, the Bureau of Labor Statistics reported that median usual weekly earnings for 2Q14 were down 0.3% from 2Q13 (note: the median refers to the middle point in the distribution – half had higher earnings and half had lower earnings). Adjusting for inflation, median usual weekly earnings were down 1.2% from a year ago and are roughly at the same level as ten years ago. Aggregate wage income (and in turn, aggregate spending) can still increase as long as job growth is positive, but the weakness in inflation-adjusted average wages has been a limiting factor for consumer spending growth.
Last week, the report on durable goods orders and shipments included some disturbing details. Shipments of nondefense capital goods excluding aircraft fell 1.0% in June, the third consecutive quarterly decline. Shipments still rose moderately in 2Q14 (thanks to a 2.2% weather-related rebound in March), but the trend points toward a subpar pace in 3Q14.
Job growth has been one of the most positive stories in the first half of 2014. Prior to seasonal adjustment, the economy added 3.85 million private-sector jobs between February and June. However, part of that reflects weather-related weakness in the early part of the year. Job destruction has remained low (it hasn’t been an issue in the last few years) and new hiring appears to have picked up. However, there is a fair amount of statistical noise in the payroll figures (the monthly change in payrolls is reported accurate to ±90,000). It’s not unusual to get a string of monthly figures above or below the underlying trend. Hence, the recent trend in payroll growth is encouraging, but hardly conclusive. Unfortunately, financial market participants essentially have to take the payroll numbers at face value.
By week’s end, economists will have a clearer (but still distorted) picture of the near-term trends, which may lead to downward revisions to GDP growth expectations for the second half of the year (a bit below 3%, rather than a bit above).
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