The first estimate of second quarter GDP was released this morning and at 2.1% it beat the 1.8% Bloomberg consensus and the more pessimistic 1.3% Atlanta Fed GDPNow estimate. The quarterly results represent a slowing from the 3.1% first quarter print, but that was largely expected. The inventory build and net export activity that boosted first quarter results reversed in the second while the consumer and governments increased their spending well above the first quarter, and better than expectations, and that kept GDP growth from dipping further. The GDP beat, however, isn’t likely to deter the Fed from its expected 25bps rate cut next Wednesday. Expectations for third and fourth quarter GDP remain in the 1.8%-1.9% range so the level of output seems to be settling in the 2% area for the balance of 2019. That modest growth expectation is likely to keep the Fed in easing mode into the fall and winter, especially if trade-related issues remain problematic and other overseas economies continue to struggle.
As mentioned above, second quarter GDP growth was 2.1% quarter-over-quarter annualized versus the 1.8% Bloomberg consensus. As expected, second quarter growth trailed the 3.1% first quarter print that was boosted by inventory build and outsized net export growth that was a result of front-running the imposition of tariffs. The offset to the one-off growth in the first quarter was the consumer returned to his profligate spending ways and that limited the slide in GDP.
Personal consumption, which is two-thirds of the economy, grew by 4.3% versus the 4.0% consensus forecast, and well above the 1.1% first quarter print. The consumption gain is the highest quarterly growth since the fourth quarter of 2017. Without the solid rebound in consumer spending second quarter GDP would have been barely positive. That’s a reflection of the importance of the consumer to GDP results and if we are to slip into a recession it will be because consumer confidence nosedives and spending retreats as a result.
In the prior three quarters, GDP was helped by rising inventories and a smaller-than-expected trade gap. Those areas reversed in the second quarter, cutting 1.51% from GDP, but the consumer stepped into the breach to keep GDP from falling further. While inventories, net exports and government spending can be volatile from quarter to quarter one metric that avoids those categories is real final sales to private domestic purchasers and that number was up a solid 3.2% versus a modest 1.6% and 1.7% in the prior two quarters.
While the consumer stepped up in a big way in the second quarter, business investment remains a trouble spot. Business investment dipped -0.6% versus 4.4% in the first quarter as spending in the energy sector slowed as a consequence of oil prices dipping during the quarter. The dip in spending is counter to what the Fed wants to see and only increases the reliance on consumer spending for economic growth.
Annualized core PCE for the second quarter rebounded to 1.8% from 1.1% in the first quarter, but that missed the 2.0% expectation. While the Fed will welcome the bump in core PCE for the quarter, it won’t deter a rate cut next week as monthly figures continue to point to inflation remaining under the 2% benchmark, (next Tuesday’s June core PCE is expected at 1.7% YoY). With other major central banks moving forward with additional easing measures (see the ECB below), the Fed is fighting against persistent dollar strength and that will add to ongoing price deflation from imports preventing a material increase in inflation; thus, rate cuts will be seen as one way to try and stem persistent dollar strength.
In the end, while second quarter GDP posted a modest 2.1% growth rate, that came with outsized consumer spending that’s not likely to be repeated, and third and fourth quarter estimates are in the same 1.8%-1.9% range. That moderation in growth, along with tepid business investment, and the prospects for continued dollar strength and global uncertainty will lead the Fed to cut rates 25bps next week and more than likely follow that with another 25bps in September.
Speaking of other central banks, the ECB concluded its policy meeting yesterday with no change in rates but President Mario Draghi did indicate a rate cut and other accommodative measures would be coming in September. Bloomberg expects the policy changes to include a 10bps rate cut and a relaunch of quantitative easing in the 45 billion euros/month range. His comment that the outlook is “getting worse and worse” reflects a material slowing in manufacturing that is coming from increased uncertainty over trade (read possible Trump tariffs) along with Brexit uncertainties. Those uncertainties only increased after new Prime Minister Boris Johnson installed mostly pro hard-Brexit ministers to his cabinet increasing the chances of that that outcome becomes reality in October.
U.S. Dollar Strength Persists
As mentioned above, the U.S. economy stands apart from most of the other developed economies in the world with decent growth. Partially as a consequence of that dichotomy the dollar has been strengthening against most other currencies for the past year. While off the May highs after rate-cutting odds increased, further slowing in major overseas economies is likely to limit any decline in the dollar. The implications of that are: (1) continued headwinds on the trade front as exports increase in cost for potential foreign buyers, and (2) decreasing import costs. Thus, dollar strength will be another factor keeping the Fed in easing mode despite decent GDP results.
|Treasury Curve||Today||Chg Last Wk.||LIBOR Rates||Today||Chg Last Wk.||FF/Prime||Rate||Swap Rates||Rate|
|3 Month||2.10%||+0.10%||1 Mo LIBOR||2.26%||UNCH||FF Target Rate||2.25%-2.50%||3 Year||1.837%|
|6 Month||2.09%||+0.02%||3 Mo LIBOR||2.27%||+0.01%||Prime Rate||5.50%||5 Year||1.832%|
|2 Year||1.87%||+0.05%||6 Mo LIBOR||2.18%||+0.04%||IOER||2.35%||10 Year||2.000%|
|10 Year||2.08%||+0.02%||12 MO LIBOR||2.18%||+0.02%||SOFR||2.42%|