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Monday, October 20, 2003

Strong US Third Quarter GDP Anticipated

A fairly Upbeat piece on the US economy from Caroline Baum in Bloomberg today, even if her immediate prognosis is downbeat: she thinks - as does nearly everone else - that the third quarter GDP numbers will be high, but that they will fall back in the fourth. Nothing really controversial here. She is however fairly positive on what this will mean for mid-term growth. I think that the jury is still out, but that we need to consider all the data, and the arguments carefully. John Snow is making noises about raising interest rates. Short term I think this is just about trying to appear 'bullish'. OTOH: the numbers do give the surprising impression that the summer tax 'stimulus' had more impact on consumption than many foresaw (although, the let-out is that the whole package was a compromise one, so there is something for all parties). With so much shouting going on, it is sometimes difficult to see what the real argument is. The notorious GWB 'tax cut' is primarily a long-term phenomenon. What we have been seeing in September is a short term package to try to lift the economy up into full recovery. Looking at the consumption numbers, it's hard to argue a bigger short-term stimulus was needed, the question is: is this sustainable. Here we enter other areas like the trade deficit, private indebtedness, the level of private saving, the baby boom and long-term fiscal stability. One of the dangers of overly politicising your interpretation of things, is that you may lose-out on the subtlety of your analysis. Of course, some people see what they want to see, and that's it.

With most of the third-quarter economic data reported, economists are honing (read: raising) their forecasts for gross domestic product growth. Last Friday's report of a smaller-than-expected August trade deficit and Wednesday's upward revision to July and August retail sales were the latest data points to raise the consensus GDP forecast to something on the order of 6 percent. With two-thirds of the economy -- consumer spending -- growing at an estimated 6.5 percent rate last quarter, it's hard to manufacture a much weaker GDP number. Tax cuts, auto incentives -- probably the weather -- will be cited as the reason for the strength in third-quarter consumer spending and the reason to expect a fourth-quarter retrenchment. No disagreement here. Real consumer spending has increased an annualized 6 percent or more in only three quarters in the past decade -- none of them back-to-back. It's tough to make a case that the consumer will follow his third-quarter shopping bonanza with a strong second act. That doesn't mean the expansion is doomed. Growth dynamics may change from one quarter to the next without jeopardizing growth itself. Some of what consumers bought in the third quarter came out of inventories. With business stockpiles at an all-time low relative to sales (almost as ``unsustainable'' as the current- account deficit), companies will have to step up production so they don't lose sales.

``A key cyclical dynamic is the boost to growth that comes from the inventory cycle,'' says John Ryding, chief market economist at Bear, Stearns & Co. Not only are inventories at an all-time low relative to sales, but accumulating them is also starting to make good business sense. With industrial commodity prices soaring and the federal funds rate pegged at 1 percent, ``the holding profits on inventory have been rising sharply, which should result in a boost to inventory investment over the next two quarters,'' Ryding says. All-consumer-all-the-time isn't a necessary prerequisite to sustain economic growth. Just as consumer spending started the summer quarter off strong and ended it weak, production went in the opposite direction. Manufacturing output posted its biggest increase (0.7 percent) in September since April 2000. The 2.9 percent annualized third-quarter increase was powered by a 25.6 percent jump in high-tech output. Excluding motor vehicles and parts, the September manufacturing increase was a modest 0.2 percent. Still, the breakdown of that output confirms that businesses are taking some of the load off the consumer. The output of business equipment rose for a fifth consecutive month in September. The third-quarter rise of 5.2 percent (annualized) was the biggest in three years. Business equipment production fell for 15 consecutive months from October 2000 through December 2001, alternating an occasional monthly increase with losses for the next 15 months. From May through September, the changes were all positive, confirming the more optimistic outlook in CEO surveys and the increased demand reflected in new orders. Inventories could easily make a positive contribution to GDP growth in the current quarter and in the first half of 2004, according to Henry Willmore, chief U.S. economist at Barclays Capital Group. In addition, consumer spending should get a boost from ``a significant tax refund because of over-withholding,'' he says. (The tax cut was retroactive to January 2003. Employers adjusted the withholding schedules in July.)

Come the second half of next year, however, ``we'll need to have job growth'' to sustain the expansion, Willmore says. Job growth may already be in the process of accelerating. Weekly unemployment claims fell to an eight-month low last week even as the total number of people receiving unemployment benefits failed to show any improvement. Firing has to stop before hiring can begin. If yesterday's buoyant reading from Philadelphia-area manufacturers is any indication, the latter is in the cards. The employment index rose to a three-year high of 5.5 while the gauge of employment six months from now rose to a two-decade high of 33.3. Employment was only one part of the upbeat Philly Fed survey, with the general activity index at a seven-year high of 28. New orders and shipments showed sizeable increases as well. The regional and national purchasing managers surveys, while qualitative in nature (increase, decrease or no change?), tend to lead quantitative data, such as industrial production. The upswing in a variety of manufacturing indicators, including the rise in commodity prices, ``is normally associated with a resumption in employment growth,'' Ryding says. Strong sustained growth, which isn't relegated to consumer spending, will deliver jobs.
Source: Bloomberg

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