Last week we learned that according to initial estimates, the US economy grew by just 1.2 per cent at an annual rate in the second quarter of this year. This is the same as the go-slow eurozone and half the speed at which the UK grew: our GDP rose 2.4 per cent if measured on the same basis. But before we Brits crack open the champagne, or we all get sullen over the US economy’s disappointing performance, we need to look a little more closely.
Subject to fuller data gathering and analysis, it looks as though most of the UK’s GDP rise happened in April and that things were definitely going off the boil by the time the referendum took place. In any event, as I explained last week and as others have made clear, the data sets we have had since the 23rd June point strongly to a weak economy in the third quarter of this year, with a high risk of a contraction that could easily extend into the tail end of the year. Technically, two or more contractions and we will officially be in a recession. There’s not much we can do about this now. We will have to wait until the Bank of England’s Monetary Policy Committee meets next month, and then much later the Autumn Statement, to see how policy-makers choose to respond.
A deeper dive into the US economy
But while a Brecession was always on the cards, the US numbers did constitute a minor shock. The 1.2 per cent in the second quarter follows anaemic growth: 0.8 per cent in the first quarter and 0.9 per cent in the last quarter of 2015. The US dollar fell back—including against the beleaguered pound Sterling—and the chance of a further rise in US interest rates before the end of 2016, measured by market probabilities, fell back from 50 per cent at the start of the week to 33.7 per cent. It’s troublesome enough to imagine what kind of damage might befall the US economy in the event that Donald Trump should reach the Oval Office, but it behooves us to ask: what ails the US economy now?We know that as elsewhere, the US economic recovery since the 2009-2010 recession has been one of the weakest on record, in spite of high employment creation and a very low unemployment rate. Productivity growth has been poor, wage and salary formation weak… you know the story by now. That said, the US has been growing at a continuous rate of about two per cent per annum, even if the quarterly data have been significantly more erratic. And even through the second quarter, the annual rate of growth was 2.1 per cent.
Looking through the new data the good news is that personal consumption spending rose by 4.2 per cent, the strongest increase for many quarters. It is almost certainly not going to continue at this pace, and was helped along by a drop in the personal saving rate from 6.1 per cent to 5.5 per cent. This generated about half the increase in household disposable income in the quarter. The US personal saving rate has remained at an elevated level regardless, and so even if consumer spending does slow down a bit, households don’t look as though they are about to pull in their horns significantly.
It was also announced last week that the rate of compensation growth for US employees, measured by the Employment Cost Index, rose by 2.3 per cent in the year to the April-June quarter, the best performance since 2008. Wages and salaries, which comprise 70 per cent of the index, grew by 2.5 per cent, and benefits by two per cent. With the consumer price index running at one per cent, this at least makes for some real increase.
The inventory problem
Another veiled source of good news in the GDP report was that US companies ran down their inventories. The way inventories enter GDP needs a quick explanation. When inventories grow faster than in the previous quarter, they boost GDP. If they grow but less quickly, they subtract from GDP—and this is what’s been happening for the last four quarters. In the second quarter of this year, there wasn’t just slower inventory building but an outright decline in inventories. As a result, the inventory data lowered GDP by 1.2 per cent, the largest negative for many years. What economists call “final sales,” which is GDP less inventories, therefore grew by 2.4 per cent, rather than the 1.2 per cent for GDP. This is more in line with what’s been happening for the last couple of years.In fact, if we look even deeper, we can see that retail, wholesale and business inventories have been rising steadily since the period 2010-2014 when they were broadly constant in relation to sales. But during last year and early 2016, the inventory-to-sales ratio grew to levels rarely seen: there’s no question that the economy has been going through a major inventory correction. It may not quite be over yet, but all things considered, this is a necessary development that should set the scene for a rise in GDP growth later this year. For what it’s worth the New York Federal Reserve’s current tracking of third quarter economic data suggests a tentative 2.5 per cent increase in GDP.
The bad news is on investment
The bad news in the GDP report was without doubt the data on investment. Housing investment fell by 6.1 per cent, an outcome that doesn’t quite match with anecdotal numbers we have about the US housing market, so this could be an aberration. But non-residential investment fell by 2.2 per cent after back-to-back falls of 3.3 per cent and 3.4 per cent in the prior two quarters. This really is a cause for concern, since the outlook for so much, not least productivity, depends on investment in equipment and buildings, which has been weak—in contrast to investment in intellectual property products which has been quite buoyant.It is possible that much of the weakness in investment could be traceable to the oil, gas and mining sectors, which have had to adjust quickly to the plunge in commodity prices that gathered pace between last autumn and this spring. On the other hand there are also well-known reasons for the weakness of investment, including the weakness of after-tax earnings at the moment, as well as more structural phenomena such as demographics, and the capital-conserving properties of new technologies employed in business models operated by the likes of Google, Amazon, Uber, and Air BNB. We shall have to see how capital spending holds up after the summer, but persistent weakness would not be a good signal.
We will get GDP revisions for the second quarter at the end of September and it is worth noting that the historical average revision from the advance estimate we have just had to this later estimate is 0.5 per cent (plus or minus). But by the time we get the advance report for third quarter GDP on 28th October, our focus will be on the US election—it will be a short 11 days away. That will probably tell us more about the US economic outlook than anything else.
