US GDP Stands Pat at -1% Despite Expectations of a Bigger Decline

The second, or preliminary, estimate of GDP for the second quarter was left unchanged from the first, or advance, estimate of -1%. This represented a modest upward surpriseas expectations had been for the report to show an intensification of the quarterly decline to -1.5%. The second-quarter decline continues to reflect a marked easing in the pace of decline relative to the sizeable 6.4% plunge recorded in the first quarter.

Expectations of an intensification of the decline in activity in the second quarter were largely based on recently released monthly numbers that had flagged a greater drawdown in inventories and greater weakness in business investment spending. Today’s report confirmed these expectations, with investment spending now dropping 10.9% compared to the previously estimated -8.9%, while the drawdown in inventories is now subtracting 1.4 percentage points from overall growth compared  to a previously estimated 0.8 percentage points. However, the main offsetting upward surprises were an easing in the pace of decline in both consumer spending (from -1.2% to -1%) and residential investment (from -29.3% to -22.8%).

Annualized quarterly growth in the core PCE deflator, the key inflation measure in the GDP report, was left unchanged at 2%. Corporate after-tax profits were up 2.9% in the quarter after a 1.3% rise in the first quarter.

Although today’s report continues to show an economy declining in the second quarter, the pace of decline has eased sharply and the composition was more favourable, with a greater drawdown in inventories being offset by less weakness in consumer spending. Thus, the report will likely not alter the emerging view that the economy returned to positive growth in the third quarter since rising demand will increasingly need to be met with new production.

The main driver in the expected third-quarter gain is a projected return to positive growth in consumer spending after the 1% decline in the second quarter. This rebound in household spending will be significantly boosted by the “cash-for-clunkers” rebates. However, with consumer spending on products other than autos expected to remain sluggish and investment spending projected to continue to decline, the overall third-quarter GDP increase is expected to be a relatively moderate 1.5%.

This represents a still very modest pace of growth and one that will not prevent the unemployment rate from continuing to rise. With unused capacity continuing build in the economy, the Fed is expected to maintain the current very stimulative monetary conditions. We do not anticipate Fed funds rising from its current range of 0% to 0.25% until the final quarter of 2010.