U.S GDP data fails to deliver on Fed hopes

Recent GDP data from the U.S shows a slower than expected recovery and questions QE exit expectations.

Strong macro numbers from the US on Tuesday were seen as supporting evidence that the Fed will continue with its tapering later this year or in 2014.

Durable Goods orders (3.6% vs. 3.0% exp.)
Core Durable goods orders (0.7% vs. 0.0% exp.)
CB consumer confidence 81.4 vs. 75.2 exp.
New home sales 476,000 vs. 462,000 exp.
S&P/CS Composite HPI 12.1% vs. 10.6% exp.

However, yesterday's GDP figures have put a serious question mark over the whole recovery/tapering story. Q1 GDP was revised down from an annual rate of 2.4% to 1.77% in its final revision. Final sales to domestic purchasers were revised down from a 3.2% annual rate to 1.3%, the slowest in two years. That means demand in the economy was much weaker than what the Fedexpected as the fiscal belt tightened in Q1.

Personal Consumption Expenditures (PCE) was responsible for 2.4% of the GDP number in the first revision but fell to 1.83% in the final revision. In absolute terms, PCE collapsed from 3.4% to 2.6% on expectations of 3.4%. The PCE measure is used by the Fed in its analysis and forecasting of the U.S economy so it was surprising to see market speculators not pay more attention to the disappointing GDP figure.

The downward GDP revision mostly reflected softer spending on services, which rose just 1.7% instead of 3.1% as previously reported. Americans spend about 70% of their disposable incomes in the services sector. Investment in business structures such as office buildings and plants also fell a steeper 8.3% instead of 3.5%. The plunge in investment reflects the cautious approach of American businesses in the face of a soft economy at home and declining growth among key U.S. trading partners such as China and India.

Source: BLS.gov 

Another factor that is potentially even more worrying is that fixed investment continues to decline rather than rise or remain flat. Economic recoveries tend to have rising levels of fixed investment as low interest rates encourage spending and growth. The fact that we (and the Fed) are seeing worsening levels of consumption and investment is indicative that the U.S. is not recovering and will probably resort to more Fed support rather than less. Its the expectations of tapering that are likely to ebb away rather than Fed asset purchases.

The root of the problem is that U.S consumer-spending accounts for circa 70% of U.S GDP but quantitative easing has not, and will not, help the average consumer because the additional liquidity is going to banks and other corporations - not consumers. QE does nothing for disposable incomes which is what drives consumption. The Fed's asset purchases are not effective because they are going to the wrong recipients. Bank balance sheets are being propped up and this is preventing the market from clearing in accordance with demand and supply. Post Lehman/GFC markets are in a form of sclerosis whereby they need asset purchases simply to keep functioning month to month. And the Fed keeps the market dysfunctional by providing artificial demand that shouldn't be there. Just like a drug addict the financial 'market' is now in close partnership with its favourite [drug]dealer. And soon the junkie will demand a higher dose at better prices.

Source: Wall Street Journal

U.S. policymakers from the Treasury, White House and the Fed have subsidized a weak economic recovery via food stamps, social programs and a spike in government jobs but the private sector is lagging with most of its hiring coming in the form of temporary or part-time jobs. The irony is that the U.S. consumer while over-levered and under-saved, is expected to be the catalyst for a strong economic recovery.

For us, the revised GDP number gives rise to some interesting observations:

• The GDP figure was revised so significantly on its 3rd estimate (usually, final GDP figures are only minutely revised because the errors found in the initial reading are adjusted in the 2nd reading)
• The huge decline in GDP did not cause a negative market reaction - instead, investors mostly shrugged off the backward-looking GDP report and U.S. equities rose sharply
• Market participants are solely focused on Fed policy and are addicted to Fed support. Bad economic news means the Fed will make more asset purchases so stocks rise. Good news means everything is recovering all by itself, so stocks rise. The only way for equities/bond/commodities to fall is when investors believe the Fed is not a market participant anymire. Sad times indeed. Fed policy has created a zombie-style market where participants are not concerned with economic reality, but merely with paper valuations of assets that despite being artificially high, are maintaining the status quo. It seems the Fed is behaving like a day trader with minimum price targets - how sustainable this whole fiasco is, only time will tell.

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Commissioned by Think Forex

Written by George Tchetvertakov

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