Johnson: One of the Worst GDP Reports in Some Time

Bob Johnson: This morning’s third-quarter GDP report showed a surprising strong growth rate of 2.9% in the third quarter, versus 2.5% in terms on the consensus and our forecast of 2.4%. So clearly, on a headline basis, a very strong number, and certainly better than the 0.8% and 1.4% we had in the first two quarters of the year. Seemingly some nicely improving numbers.

Despite that, we feel it is one of the worst GDP reports that we’ve seen in some time. The quality of the report was exceptionally low with a lot of the growth coming out of special factors. Exports in the quarter were up about 10% led by a giant move in soybean shipments. And so that had a big impact on the numbers, and exports contributed an amazing 1.2% to the GDP number. Without that number, and most of that was soybeans, the GDP number would have looked much more disappointing.

Also, inventories added 0.6% to GDP. Usually when you are building inventories we view that as not such a great thing. Clearly that is another special factor that helped the numbers along. I will comment that we finally broke our string of five quarters of inventories shrinking and hurting GDP and now we are starting to build some of those inventories back up again. But nevertheless, that’s not how I like to see the economy really grow.

Looking at some of the other numbers in the report, the things that I found so disappointing--and these are things that are usually the core of the GDP report, the things that I really care about--consumption was surprisingly disappointing. Business equipment was down yet again. We had a number of issues that were a problem. And even residential, one of the seemingly strong areas of the economy, had another quarter of weakness. Those are three things that I really view as the hub of GDP and they were actually all down and perhaps just a tad disappointing as well.

The consumption number, the growth came in at about 2.1%. That number was over 4% in the second quarter and it has averaged something a little closer to 3% over the last year or two. Clearly, at 2.1% it is a disappointing number. And consumption, remember, is 70% of GDP and it generally drives, indirectly, some of the other categories of GDP. We were very disappointed to see that number as low as it is. Some of the auto data affected that number and some of the services side grew a little bit weaker too. Not a good scenario on consumption, which we view as the key part of the GDP report. Clearly an issue there.

We will say, we broke the inventory string, we got government spending up a little more at least on the Federal side, and that also helped GDP along a little bit, but it was mainly those special factors that saved us from a pretty disappointing GDP number. 

I really like to look at the numbers on a year-over-year rolling four-quarter basis because you get things like these soybeans exports, clothing because of warm weather not selling, if you look at a single quarter and annualize it, it kinds of distorts the number. So I like to look at the number on a year-over-year basis and use a rolling four-quarter average. There the numbers were particularly disappointing. From early 2015 we’ve gone from 2.9% growth or so all the way down to about 1.6% right now with today’s latest data. We really have had quite a falling out there. And I think that 1.6% better represents where we are versus the 2.9%.  That’s a better way to look at it. Even using a 3% growth forecast for the fourth quarter, that number is going to remain in that mid 1% range (1.5%, 1.6%) even into the fourth quarter which means we will close out the year with that 1.6% growth rate. Which is clearly way down from the 2% to 2.5% we’ve been seeing more typically and down from the 2.6% we saw in 2015.

Going forward, demographics are going to have a big impact on GDP. I think we will probably see growth next year more in the 1.5% to 2% range, somewhat similar to what we saw this year. Kind of down from earlier in the recovery when we were growing over 2%. A little bit of a slowing going on here in the economy and it will keep a little lid on employment as well.

One thing that will be very interesting to see is that the headline number was amazingly strong at 2.9%, will the Fed see through it? I think they will. I think it is pretty easy to strip out the exports and the inventory data and look at it and say “gee this wasn’t such a great quarter.” The GDP number today was not so good or so bad that I think it will really influence the Fed’s decision. Instead, I think they will be looking ahead to what happens with retail sales, what happens to inflation and what happens in the next two employment reports. That in my mind will be the key to the Fed’s decision. Today’s GDP report provided no answers.