U.S. Q1 GDP could be even more disappointing than recent years

April 26, 2016

U.S. Federal Reserve Board Chair Janet Yellen testifies at the House Financial Services Committee in Washington February 10, 2016. REUTERS/Gary Cameron - RTX26D37

U.S. first quarter economic growth, if there is any, is set to be disappointing once again, with private forecasters providing the most pessimistic first-take view for the start to the year since the recovery from financial crisis began.

And yet the Federal Reserve is still set to raise interest rates again by June.

Cold weather was the main culprit for new year weakness over the past few years, spawning debate over the trouble official statisticians are having seasonally adjusting the data. That debate still rages.

Lou Crandall, economist and Fed watcher at Wrightson ICAP, sums up the current mood:

As many analysts have pointed out, the Commerce Department has not yet succeeded in eradicating the downward Q1 bias in the GDP numbers in general, which will give the Fed an excuse for looking past this particular report. (Our own view continues to be that the Fed and the market should “look past” every GDP report, as the data are much too unreliable to be used for real-time policy analysis.)

He is not alone in warning clients to steer clear of taking decisions based on the volatile GDP numbers. But given that the start of 2016 was one of the warmest on record for the United States, not the coldest, suggests that it might not be entirely prudent, as some policymakers have suggested they might, to completely write off the data.

After all, this has been the most sluggish and uneven economic recovery in living memory.

US slow recovery

The lack of inflation it has generated is the main reason why the Federal Reserve has only managed so far to raise interest rates just once off the zero bound to 0.25-0.50 percent. Rates are exceptionally low for a jobless rate of 5 percent, which otherwise would suggest the economy is close to full employment.

The Reuters consensus from 112 economists is for just 0.7 percent annualized growth in Q1, half the already modest pace recorded in the previous three months. The data are due for release on April 28, the day after the Fed winds up its latest policy meeting.

Reliable or not, we know that much of the sluggishness is real, and has to do in part with a slowdown in consumer spending.

Economists are once again forecasting a pickup in the second quarter to an annualized rate of 2.3 percent, similar to forecasts made in previous years for an acceleration that comes but is never sustained. In Q2 last year, growth came in just below 4 percent at final reading, and clocked 4.6 percent in Q2 2014. But the economy hasn’t been able to match the peak 5.6 percent growth rate in Q4 2009, which itself is much weaker than previous bursts of growth during past recoveries.

Considering how economists have over-estimated growth at the start of a year every year since 2010, the 0.7 percent consensus for Q1 probably ought to be taken as optimistic. (The Atlanta Fed, which does a real-time forecast, forecasts the economy came close to stalling in the first quarter, currently at just 0.3 percent annualized growth.)

And advance releases of GDP have missed the consensus more often than not over recent years.

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The advance Q1 GDP miss versus the Reuters consensus in 2014 and 2015 was substantial. Repeating that experience would suggest that the economy officially shrank in the quarter just following the first Fed interest rate rise in nearly a decade.

If the data weren’t such an easy candidate for dismissal on grounds of seasonal distortion, that would suggest a brittle economic backdrop indeed.

Apart from missing the consensus expectation for the last seven years in a row (as well as the sustained robust recovery), there are several other details in the data that suggest advance Q1 GDP could show the same pattern again:

  • The lowest forecast in the latest Reuters poll, for example, is the most pessimistic estimate for any advance GDP release since the recovery began.
  • The range of forecasts is narrower, with the most optimistic view about one percentage point lower than in previous years.
  • The most accurate forecasters for the U.S. economy in Reuters polls through all of last year have pencilled in 0.5-0.8 percent growth, lower than the 1.0 percent average forecast the majority of them had for Q1 2015.

Bernd Weidensteiner at Commerzbank explains the choppy GDP performance this way:

What we are in fact seeing is the normal volatility in GDP growth rates. With the U.S. trend growth rate likely to have slowed to only 1¾%, there will be quarters when growth rates are low or even negative even though the upward trend remains stable. These fluctuations will not prevent the Fed from raising interest rates in the longer term, even though the central bank will sit tight again (in April).

Well, yes and no. GDP didn’t fluctuate by quite this much in recoveries from past recessions, and this recovery has been much weaker than average.

Those dismissing the official U.S. growth data as indicative of a trend are pointing instead to the robust labor market, where more than 200,000 jobs are being created every month. First-time claims for unemployment insurance have once again hit a 43-year low. But even in the job market there’s still a fair amount of slack.

Economists at BNP Paribas wrote about this week’s Fed rate decision:

If our forecasts are realized, it will be challenging for the Fed to say that activity is still expanding at a “moderate pace.” A year ago, the Fed acknowledged that “economic growth slowed during the winter months, in part reflecting transitory factors.” The Fed might use similar language again, but this time it may be harder to argue that the slowdown reflects “transitory factors.” After all, the slowdown has lasted for two quarters and there were no port strikes or weather disruptions unlike last year. Some could argue that residual seasonality is to blame once again, but others may be more skeptical. After all, part of Q1’s weakness seems to have reflected softness in GDP components that typically are less affected by residual seasonality (consumption and business fixed investment).

The Fed needs solid evidence in the data to justify another interest rate hike in June, as is now widely expected. So whether or not growth, and along with it inflation, accelerates between now and then will matter a great deal.

— Analysis and reporting by Krishna Eluri and Sumanta Dey

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