GDP Propped by Govt & Consumers for Now
The advanced report of US Q3 GDP showed a 3.8% annual growth from 3.3% in Q2.
The report saw its largest positive contribution from personal consumption expenditure (2.73% from 2.35%) and government expenditure (0.61% from 0.47%). The latter resulted largely from a 10.2% rise in national defense spending following a 3.7% increase in Q2. Gross private investment's contribution turned positive at 0.38% from a negative (-) contribution of 0.63%.
Although gross private investments contribution rose above zero, it was the lowest positive (above zero) contribution to GDP growth since Q2 2002 when it reached 0.30%. On the external side, net exports' contribution fell to 0.08% from 1.11%, making this the lowest positive contribution since matching the figure in Q1 2003. The negative contribution from private inventory investment of 0.55% was the lowest in dollar terms since Q4 2001, when companies' reduced inventories were not replenished following the attacks of Sep 11. The 1.4% drop in business investment in structures and the near halving of fixed income investment to 5.7% does reflect a retreat in spending from the business sector.
On the inflation side, the Q3 PCE price index rose 3.7% from 3.3% while the core PCE price index slowed to 1.3% from 1.7%, reflecting the monthly rising food and energy phenomenon prices in the monthly CPI data. Nonetheless, as we have seen in the monthly core PCE price index data, the figures did regain the 2.0% level in August yet was below the 2.2% registered in Dec 04-Feb 05. As these data show relatively acquiesced core inflation, the Fed has no reason to become aggressive. As long as core annual CPI remains at 2.0%, markets can safely expect fed funds to peak at 4.50% in January. It is important to note that markets are pricing the incoming 3 rate hikes on the basis of the Fed's aggressive anti-inflation rhetoric rather than on the data.
Moving to the Bernanke-inflation projection, the question remains on whether the Fed chairman nominee will be as resilient in combating inflation as he was resilient and vocal in tackling disinflation 2 years ago. We expect the earliest challenge facing Bernanke to come in late Q1-Q2 when a slowdown in GDP growth will not be accompanied by a retreat in inflation. We expect that a retreat in consumer demand (see below) will take a bigger bite out of growth, while second round price effect to filter through goods and services into the Q2.
How Reliant are Consumers?
Government and consumers - the other sectors making up the void from businesses were instrumental in adding a gross 3.3% to GDP growth. But given a lackluster projections for a Q4 earnings season, and the cusp of weakening consumer demand from rising energy costs, the prospects of a continued substitution in the consumer-business spending swap appears relatively low. The Energy Information Association projects an average of $350 increase (48%) in natural gas for household heating this winter compared to last year; and an average increase of $378 (32%) in heating oil. Those using electricity can expect an average increase of $38 (5%) in their heating bill. Since December heating bills arrive in January, consumers would have already made their Holiday spending and begin to be impacted in January. Thus, the double blow from holiday shopping and higher heating costs should surface in the New Year, at a time when the stock market could be afflicted by a disappointing post-Hurricane and post energy Q4 earnings season.
Today's downward revision in the October Univ of Michigan report on consumer sentiment to a 13-year low of 74.2, following Tuesday's release of a 2-year low in consumer confidence remains a case in point
On the housing sector, it's worth reminding that Thursday's release of the 2.1% increase in September new home sales avoided a drop due to the upward revision in the decrease in the August figure, which registered a 12.8% decline to 10-month lows-- the highest monthly decline since January 1994.
This week's decisive dollar move did not take place after Monday's presidential nomination of Ben Bernanke to the Fed Chairmanship but on Tuesday, when the currency was punished across the board on a combination of slumping US consumer confidence (2-year low) and higher than expected German business confidence in Germany (5-year high). This week, the dollar posted its second weekly gain in the past 8 weeks versus the euro and sterling reaching the 100-day moving average for the first time in 6 weeks--and the third weekly gain over the past 8 weeks. Against the yen, the dollar has entered an 8-day consolidation after a steep 5.5% run-up between Sep 12 and Oct 18. Technically speaking, the relative strength index of oversold/bought measure has reached a 5 week low of 50%, while the MACD indicator of dual moving averages has started its first bearish signal since September 6.
The Bank of Canada's readiness to see further CAD gains resulting from higher commodity prices does suggests the central bank will neither stand in the way of further CAD gains nor will reconsider its plans to tighten further in order to contain inflationary pressures.
Although the technical picture for the dollar is beginning to recede, the fundamental picture remains kinder for the US currency on the basis of further rate hikes until the data begin to get the attention of the treasury market. This would happen through a renewed retreat in 10-year yields relative to the 2-year end.
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