Is US GDP growth collapsing? Atlanta Fed model says reason to worry
28th January 2016
On January 20th the economists at the Atlanta Federal Reserve released their latest projection of US GDP growth, where their GDPNow model forecast for Q4 2015 is now 0.7%, up from 0.6% on January 15.
A small positive revision, but around half of what was expected for Q4 2015 at the end of December, when the model forecasted an annualised1.3%, which itself was half the reading from early November. Digging into the model reveals that the main detractor is a big fall in the consumer spending component and a significant negative inventory adjustment.
If their model proves to be correct (we’ll get the preliminary estimate of US GDP on Friday afternoon), GDP would have grown at 1.8% in 2015 as a whole, a 25% drop compared to the 2.4% GDP growth in 2014.
What interpretation should investors give to these numbers, and what are the market implications?
For those readers who are not very familiar with the model, I would first like to give a brief description of it (for a full and detailed analysis please refer to “Patrick Higgins, GDPNow: A Model for GDP Nowcasting, Federal Reserve Bank of Atlanta, July 2014”).
In the US, GDP figures are released by the Bureau of Economic Analysis (BEA), but normally with a time lag that can be important when policymakers have to take monetary policy decisions. As roughly 70% of the advance GDP release is based on public data from government agencies or other providers that has already been made available prior to the BEA official release, “nowcasts” are a real-time forecast of the official numbers the BEA will later deliver. The first official read for fourth quarter 2015 GDP growth will be released by the BEA tomorrow.
The Atlanta Fed’s GDPNow forecast is one of these non-judgmental models. It is constructed considering 13 subcomponents of GDP and, although these models are subject to errors, in general their forecasts have been accurate, and generally more accurate than consensus forecast estimates.
Regarding market implications, if the Atlanta Fed’s GDPNow proves correct then one conculsion could be that the Fed made a policy mistake in raising official rates just as the economy started to decelerate. This seems to be the opinion of the markets. Based on Fed Fund futures, the market is now discounting only one more hike of 0.25% by the end of 2016, compared to the four hikes forecasted by the Fed dots.
We think that the market has moved too far with its pessimism on the state of the US economy and where it is in its cycle. The present slowdown in US growth mainly relates to a drop in consumption, however the flip side of this is that there has been an increase in the household saving rate, presently running at +5.5% of the disposable income. This means that the large decline in the oil price is not translating into an increase in consumer spending, because consumers are choosing to save the oil windfall instead of spending it.
Meanwhile, household real disposable income is increasing at a healthy +3.8% (3 months annualised rate). This means that when consumers consider the oil price decline as permanent, and when the headwinds generated by the increase in healthcare costs abate, there is space for a consumption recovery. This can happen relatively soon, considering that the conditions of the labour market remain sound, as the US economy continues to generate more than 200K of new jobs per month, and the unemployment rate has declined to 5.0%, a level not seen since 2008.
In conclusion we accept that the downside risks for the US economy have somewhat increased, and growth could be lower than consensus expectations, not only in Q4 2015 but also in the first quarter of 2016 (the consensus forecast for Q1 2016 growth is a lofty +2.5% QoQ annualised). But we think there is too much pessimism in financial markets, at least with regards to the underlying strength of the US economy. It is our opinion that the Fed will remain supportive, delivering interest increases at a very moderate pace compared to previous cycles. But we expect US interest rates will rise at a faster rate than the now exceptionally slow rate currently implied by markets.
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