Pardon the Interruption
February 4, 2014, Tuesday, 11:44 GMT | 06:44 EST | 17:14 IST | 19:44 SGT
Recent economic data have raised some issues about the likely strength of the economy in the first half of 2014. However, you never want to hang your hat on economic figures for December and January.
Real GDP growth rose at a 3.2% annual rate in the advance estimate for 4Q13, about as anticipated. However, there were a few surprises in the details. Consumer spending rose at a 3.3% pace, relatively strong, but lower than anticipated (following the strong November numbers reported a month ago). Income growth was relatively weak (inflation-adjusted disposable income rose at a 0.8% annual rate), suggesting that we could see a moderation in spending growth in early 2014. Business fixed investment rose at a 3.8% annual rate, partly reflecting a pickup in equipment (+6.9%, vs. +0.2% in 3Q13).
The big surprise was inventories. Recall GDP is a flow (economic activity per unit of time), while inventories are a stock. The change in inventories contributes to the level of GDP. Hence, the change in the change in inventories contributes to GDP growth. Inventory growth was expected to slow in 4Q13, subtracting from the overall growth estimate. Instead, it picked up, adding 0.4 percentage point to the GDP growth estimate. A slower pace of inventory growth is expected to reduce GDP growth in the first half of 2014. Note that this is largely an exercise in arithmetic and the fourth quarter GDP figures will be revised, and revised again.
Net exports added 0.9 percentage point to GDP growth in 4Q13, but that will likely be hard to repeat. Granted, increased domestic energy production is expected to restrain growth in imports. However, amid growing concern about emerging economies, the outlook for exports has become unsettled. Trade decisions don’t turn on a dime, so we may not see an immediate reaction, but the longer term outlook is clouded.
The housing sector has also begun to stumble. Residential fixed investment fell in 4Q13, subtracting 0.3 percentage point from GDP growth. Weather may have been a factor, but there are important issues with affordability. Higher mortgages and higher home prices have reduced the ability of many potential homeowners to purchase a home. The Pending Home Sales Index sank 8.7% in December, consistent with reports of a drop in foot traffic. This weakness may also be an issue of supply (thin inventories of new homes in many areas).
Note that the rise in home prices was likely a contributing factor to the stronger consumer spending results in the second half of last year. Homeowners aren’t borrowing against their homes as they did during the boom (when, at its peak, home equity extraction was equivalent to about 8% of disposable income), but people do feel wealthier as home prices rise, which has an indirect impact on spending. Still, the pace of home price increases and low trends in household income growth raise important issues about the sustainability of consumer spending growth. Over the last year, aggregate growth in inflation-adjusted labor income, the main fuel for consumer spending growth, was driven largely by employment gains, not growth in average hourly earnings – and with a continued high level of slack in the economy, we’re unlikely to see appreciable upward pressure on average hourly earnings for some time.
The Fed has made it clear that the tapering of asset purchases in “not on a preset path.” However, officials also expect further reductions “in measured steps.” The Fed is determined to end QE3, which is seen as less effective and riskier over time. We can expect a $10 billion reduction in the monthly pace of asset purchases at each Fed policy meeting, although the Fed could speed up or slow that pace as conditions warrant. Are the recent signs of softness enough? Not really. Long-term interest rates have been falling recently, which ought to provide some support. Moreover, the Fed knows as well as anyone that economic data reports can be unreliable in the winter months. While some of the information suggests the possibility of some softness in GDP growth in the first half, none of the recent figures have dramatically altered the outlook for the economy for the year as a whole. Optimism remains.
Recent developments in emerging economies should be a cause of concern. The issue here is capital flows. There are many good reasons to anticipate that this will not be a repeat of the 1997 Asian financial crisis (currency reserves are generally higher, these countries have had some advance notice of possible strains, etc.). However, these things are really hard to predict with any confidence. The Fed will not alter taper plans based on developments overseas, but it would respond to an adverse impact on the U.S. economy, if sufficiently large.