New GDP Data is Flashing a Clear Signal at Us
“Of course, if developments emerge that cause a material reassessment of our outlook, we would respond accordingly. Policy is not on a preset course.”
- Federal Reserve Chairman Jerome Powell
“He’s not wedded to some model he was taught 40 years ago in graduate school.”
- Neel Kashkari, president of the Federal Reserve Bank of Minneapolis, on Chairman Powell
A highly anticipated update on the latest gross domestic product estimate and a highly anticipated Federal Reserve meeting in the same week? Yes please!
While CoStar Economy loves the opportunity to dive into sector- and region-specific trends as we did the past two weeks, it’s nice to be back focused on the macro economy.
Let’s start with the fourth quarter 2019 GDP estimate, which came in at 2.1% for a second quarter in a row. But don’t let this seemingly stable result fool you. This was a weird report with lots of moving parts. To be clear, most GDP reports have lots of moving parts. Take a look at the chart below.
The first stacked column is the share of GDP for each category. Unsurprisingly, consumer spending makes up roughly 70% of GDP, followed by government spending and investment, with net exports being a slight drag to growth and inventory growth nets effectively to zero.
The middle column shows how each category impacts changes in quarterly growth each quarter since 2010. Most notably, inventories and net exports, essentially net neutral contributors to GDP, are what the headline GDP numbers mostly reflect. In other words, the smallest categories have some of the biggest impacts.
Like we said, almost every quarter has a lot of noise.
Guess what two segments had the biggest swings in impact in fourth quarter? Look at the column on the right.
That’s right: trade and inventories. Inventories subtracted over 1% from fourth quarter growth after being relatively unchanged in the third. It seems this came from retailers selling out of inventory built as a precaution against higher tariffs. Relatedly, this is probably why net trade was so poor. Imports of consumer goods dropped sharply in the fourth quarter, a trend we worried about in a prior note, likely also due to importers getting ahead of potential tariffs.
With all these moving parts, it can be tough to get a read on the underlying strength of the economy in any given quarter. One method is to simply remove some of these volatile components. As proponents of removing complexity, this is very appealing to your authors.
This ex-trade, ex-inventories, ex-government figure is called real final sales of final domestic purchasers. The name is longer than it needs to be, as “core GDP” or “true demand” would also suffice. You can see this measure in the chart below along with its components, the stacked columns, charted against headline real GDP, red line.
The trend looks different compared to the headline, with our core GDP series in the fourth quarter coming in at less than half of the 2010-2019 average and meaningfully below headline real GDP. The reason for this is somewhat weaker consumption, which only added 1.2% to the fourth quarter compared to 2.1% in the third, but notably more nonresidential investment. The lack of such investment, composed of capital spent on structures and equipment, has been "subtracted" from growth for three straight quarters, undermining on of the main selling points of the 2017 Trump tax cuts that they would boost corporate capital expenditures. While there was an increase in early 2018, it appears trade uncertainty and weak global growth has meant many chose to keep their powder dry.
The issue with the underlying details of the fourth quarter is that basically all of the moving parts were pointing in the same concerning direction. Weaker consumption is negative. Weaker trade is negative. Weaker capital expenditure is negative. Weaker inventories, while volatile, are still sending a negative signal. We didn’t discuss it, but the inflation measure used to take nominal GDP down to real GDP was also weak.
This was a GDP report that seems to require a more dovish Fed, and, well, Chairman Jerome Powell and company did not disappoint in their January monetary policy meeting this week. Just about every component of the press release and the press conference afterward had a dovish lean.
The only substantive change to the Fed’s statement is that they will encourage a “return to” their inflation target, when previously they were satisfied with being “near” the target. Asked about this in the press conference, Powell said it was to show they aren’t complacent with inflation misses. They don’t want inflation just near target, they want to hit it. That suggests a lean toward lower rates.
We aren’t sure if Powell reads CoStar Economy, but the chairman echoed ourrecent piece, stating that the labor market isn’t as tight as it may seem. “The labor market is still not as tight as it would appear,” Powell said, “people are coming into the labor market and providing labor supply” which “may be holding down wages.” Mr. Chairman, boy do we agree.
Market players have taken these statements to mean a higher likelihood of another cut this year. Given the weaker underlying trends in GDP data as we head into 2020, we note that the Fed seems well attuned to the situation. That is reassuring.
The Week Ahead …
There is no rest for the weary analyst, as this week is even busier for economic data. The highlight, as in every month, is the monthly jobs report. This week will be different in that it includes the annual benchmark revision, which is likely to show that the Bureau of Labor Statistics' estimates of job growth have been overstated: Last August, the preliminary estimate of this revision projected 500,000 jobs would be removed in the coming report. Elsewhere in the report, your authors will continue to focus on the wage growth figures to see if they gain some stability after showing recent weakness.
On top of this, the Institute of Supply Management releases the results of its manufacturing and nonmanufacturing business surveys conducted in January. While both sectors have struggled recently, manufacturing has been especially weak as the sector deals with blow after blow from trade wars and a soft global economy.
Surprisingly, regional manufacturers appear to still be expanding, in spite of contractions in the national ISM index. The divergence is likely due to the ISM’s overweighting of larger, multinational corporations, which are more impacted by slower growth abroad. The regional indices show domestic conditions are somewhat better, if still not great.
CoStar Economy is produced weekly by Robert Calhoun, managing director and senior economist, and Matt Powers, associate director of CoStar Market Analytics in New York City.