Can the US Economy Bounce Back After A Wicked First Quarter?
Each release of economic data seems monumental in-the-moment. Wednesday's release of preliminary GDP figures for the period covering April to June seems even more important than usual after the terrible -2.9% growth (at an annualized rate) in the January-March period. The implications for the continued recovery and Fed's policy response could be big.
That said, the numbers we will see on Wednesday are just the preliminary estimates. They will be corrected two more times until they become trustworthy. These numbers are more of a sneak-peek of the last three months. After all, the 2.9% contraction in the first quarter was estimated to be -0.1% in its preliminary release.
Most economists and bankers believe the rough numbers at the beginning of the year were not a sign that the economy was really slowing, just that the Polar Vortex forced Americans to use extra cash as home insulation. Estimates for this quarter's growth from major forecasters all top the 2% annualized rate, and Goldman Sachs even thinks a bounce back is in order to the tune of 4%. The Federal Reserve is much more conservative at 2.1-2.3%.
The logic behind Goldman's forecast is appealing: the pent-up demand from the cold-ravaged first quarter was spent in the second quarter, combined with generally accelerating demand, will fuel a short-term spike in growth. Of course, growth is predicted to then slow some in the second half of the year. Goldman predicts 2.7% growth in 2014.
What if GDP Comes in Lower than Estimates?
Besides the Zero Hedge editors filing a few I-Told-You-So articles, lower than expected Q2 growth will show that the contraction in Q1 was more than a blip on the radar. I expect that, in this scenario, US equity markets will drop for the day between 0.5-1.0% and US Treasury Note yields will fall to near their year-long lows of about 2.47%.
Obviously, observers will quickly turn their eyes to the Fed if this happens: Will Yellen & Co. slow down the taper or communicate that rates will remain near zero for longer? Speculation will grip Twitter and TV, especially with the FOMC statement coming out just a few hours later. That is, of course, too short of a gap for the Fed to change any of its decisions after seeing the data. Even without that short gap, it is unlikely that the Fed will change course on ending quantitative easing. Chairwoman Yellen is not the character to swiftly change course, especially since she's thought long and hard about contingencies like these. Beyond that, FOMC members Richard Fisher and Charles Plossner are unlikely to push for more accommodating policy regardless of these GDP numbers.
What if GDP Comes in Higher than Estimates?
Even though forecasters like the Fed and IMF have consistently overestimated GDP growth across the US and Europe, this could be the quarter that beats their estimates. After all, all four estimates by private banks significantly top the Fed's 2.1-2.3%. This news will be undoubtedly be a sigh of relief after the first quarter. The recovery - which has at times over the last five years been too clunky to earnestly call a recovery - would seem to be back on track, and the last three month's of holding our collective breaths would be over.
Markets should respond positively and see a modest increase in equity prices and Treasury yields. Mitigating that positive attitude will be the reminder that continued growth means an end to historically-low interest rates. If growth continues as forecast, the Fed will likely raise rates in mid-2015. Markets will continue to approach good news with a sense of caution because of the impending end to a low-cost borrowing party - and I am sure a few CNBC and Wall Street Journal commentators will speculate that the news will cause the Fed to raise rates even sooner than expected. This speculation is, again, no more than speculation. Just like Plossner and Fisher are hawkish, Kocherlakota and Evans are dovish and concerned that policy will tighten too soon. Yellen also sees the value of consistency (and the concept of forward guidance in general). Good news will lead to no news from the Fed.
My reading of the economy leads me to predict that the preliminary GDP figures on Wednesday will come in at 2.9% on an annualized basis. I think the revisions may bring that number up modestly as well.