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We have not published our official estimate for 3Q10 GDP growth yet, but suffice to say it will be substantially below the current 1.7% number and substantially below the 2.5% consensus for 3Q10.   

Today’s made-up numbers from the commerce department suggest that the economy is in fairly bad shape. 

The headlines read that “consumer spending in the U.S. rose more than forecast in July.”  Personal spending rose 0.4% (the most since March, up from 0% last month) and Personal Incomes rose 0.2% (slightly less that the Bloomberg consensus).  Despite the low level of in consumer confidence in the United States, the government is telling us that consumers are so confident they feel compelled to spend their savings (the savings rate dropped to 5.9% from 6.2% last month).  Importantly, disposable incomes (the real measure of the sustainability to consumer spending trends) dropped for the first time since January. 

Despite government CPI figures, key costs on the consumer’s income statement are inflating.  Food and energy costs, especially, are currently at elevated levels.  This is putting pressure on disposable income!

Without the consumer carrying the torch of GDP growth, there might not be any growth in 2H10.  To revisit last week’s GDP figures, the revision to 2Q GDP (dropping from 2.4% to 1.6%), 80% of the downside revision came from June’s reported trade deficit deterioration.  The rest was a negative revision in reported inventory build-up.  The only upside revision was reported in personal consumption. 

Despite the consumer spending more, the reaction of today's market is rational.  The reason for this is simple: increasing consumer spending is not sustainable given the current dynamics on the macro front.  Specifically, disposable income is contracting and this will place pressure on consumer spending.  Tracking the trend in consumer confidence presently indicates that this pressure should manifest itself sooner rather than later.

In turn, this will cause increased volatility in the trade data when it is released and any changes inventory trends.  To that end, today’s news from the Federal Reserve Bank of Dallas suggests that Texas manufacturing activity remains sluggish at best.  According to the Dallas FED “the new orders and growth rate of orders indexes pushed deeper into negative territory, indicating a further contraction of demand.”  Sluggish demand suggests no need to build inventories!      

Sequentially, the inventory contribution to the 2Q10 GDP figure dropped 2% quarter-to-quarter.  For the next two quarters, we are lapping against a 1.1% and 2.8% build in inventories in 3Q09 and 4Q09, respectively.  The current trends suggest that inventory adjustment could be a drag on GDP in 2H10.  The drag is not likely to be as substantial as what we saw during the economic collapse, when inventory adjustments lowered the published GDP growth rate by as much as 2.3% during the fourth quarter of 2008. It is clear from the 2% drop between 1Q10 and 2Q10 that the current cycle of inventory building has collapsed.

Given the current trade data, inventory trends and skittish consumer behavior, how is it possible that the USA will see 2.5% GDP growth in 3Q or 2.6% growth in 4Q10? 

While government spending has played a significant role in propping up the market, one externality of such grand-scale intervention is an added degree of uncertainty in the market place.  A lack of visibility is impeding companies from making decisions such as hiring new employees; Steve Wynn is one CEO that has been particularly vocal about the unpredictability of present-day Washington.   

The leveraging of America’s balance sheet has not created new wealth; rather, in creating a zero-yield environment, it has repelled capital and resources from her economy. 

Howard Penney

Managing Director

3Q GDP GROWTH - GDP inventory chart