Economic Growth Slowing To Stall Speed

By: Paul Kasriel | Sat, Apr 28, 2007
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Real gross domestic product of the U.S. economy grew at an annual rate of only 1.3% in the first quarter of 2007, the slowest pace in four years. On a year-to-year basis, real GDP increased 2.1% in the first quarter, the smallest gain since the second quarter of 2003. The U.S. economy is essentially stalling out with the downside risks of economic growth today being larger than at the March FOMC meeting.

Chart 1

At the same time, core inflation is not entirely contained, which is typical late in the economic cycle inasmuch as inflation is a lagging indicator. The personal consumption expenditure price index excluding food and energy advanced 2.24% on a year-to-year basis in the first quarter, which is a small pickup in core inflation after a deceleration in the fourth quarter (2.19% in Q4 vs. 3.7% in Q3). On a monthly basis, we expect the year-over-year rate of increase in the core PCE price index to moderate with next week's release of the March data. According to the Bureau of Economic Analysis, a part of the increase in the price index was from a pay hike of federal civilian and military personnel, which is treated as an increase in the price of employee services purchased by the government. Excluding the impact of this event, the gain in the core price index was most likely less troubling. Moreover, the absence of a similar increase in the next quarter will work to hold down the advance of the core price index.

Chart 2

The downside risks to output growth are increasing. There is evidence that the recession in housing is starting to metastasize to the consumer spending sector. To wit, CPI-adjusted retail sales fell 0.5% month-to-month in March and their growth slowed sharply in the first quarter vs. the fourth quarter (1.9% vs. 11.1%). Moreover, officials from both GM and Ford have indicated that April motor vehicle sales are coming in very weak due to problems in the housing market. The FOMC surely is aware that inflation is a lagging indicator. In addition, the FOMC is aware that the rising rent of shelter - both explicit and implicit rents - has played an important role in driving up core consumer inflation. But with today's release of yet another record-high vacancy rate for potentially owner-occupied houses and condos, rent increases are likely to moderate as condo flippers-turned-"investors" will be desperate to rent their units. A weak April employment rate could be the catalyst for the FOMC to drop its implicit tightening bias and "go neutral" at the May 9 meeting. Regardless, we continue to expect the FOMC to begin cutting the fed funds rate at the August 7 meeting.

In the first quarter, the 3.8% increase in consumer spending, a pathetic rebound in equipment and software spending (1.9% increase vs. a 4.8% drop in 2006:Q4), a 2.2% gain in outlays on structures and a 0.9% increase in government spending provided the lift the real GDP. Partly offsetting these gains were declines in residential investment expenditures (-17.0% vs. -19.8% in 2006:Q4) and exports (-1.2%), a reduction in inventory accumulation ($14.8 billion vs. $22.4 billion), and wider trade deficit. Real final sales slowed to 1.6% annualized growth in the first quarter vs. 3.7% in the fourth quarter.

Going forward, we expect a modest rebound in real GDP growth to about a 2% annual rate in the second quarter. A sharp narrowing in the trade deficit because of strong export growth and a surge in national defense spending are the factors we expect to be responsible for this rebound, offsetting weaker private domestic spending. Without FOMC interest rate cuts commencing early in the second half of this year, we would not expect real economic growth to accelerate meaningfully.




Paul Kasriel

Author: Paul Kasriel

Paul L. Kasriel
Director of Economic Research
The Northern Trust Company
Economic Research Department
Positive Economic Commentary
"The economics of what is, rather than what you might like it to be."
50 South LaSalle Street, Chicago, Illinois 60675

Paul Kasriel

Paul joined the economic research unit of The Northern Trust Company in 1986 as Vice President and Economist, being named Senior Vice President and Director of Economic Research in 2000. His economic and interest rate forecasts are used both internally and by clients. The accuracy of the Economic Research Department's forecasts has consistently been highly-ranked in the Blue Chip survey of about 50 forecasters over the years. To that point, Paul received the prestigious 2006 Lawrence R. Klein Award for having the most accurate economic forecast among the Blue Chip survey participants for the years 2002 through 2005. The accuracy of Paul's 2008 economic forecast was ranked in the top five of The Wall Street Journal survey panel of economists. In January 2009, The Wall Street Journal and Forbes cited Paul as one of the few who identified early on the formation of the housing bubble and foresaw the economic and financial market havoc that would ensue after the bubble inevitably burst. Through written commentaries containing his straightforward and often nonconsensus analysis of economic and financial market issues, Paul has developed a loyal following in the financial community. The Northern's economic website was listed as one of the top ten most interesting by The Wall Street Journal. Paul is the co-author of a book entitled Seven Indicators That Move Markets.

Paul began his career as a research economist at the Federal Reserve Bank of Chicago. He has taught courses in finance at the DePaul University Kellstadt Graduate School of Business and at the Northwestern University Kellogg Graduate School of Management. Paul serves on the Economic Advisory Committee of the American Bankers Association.

The opinions expressed herein are those of the author and do not necessarily represent the views of The Northern Trust Company. The information herein is based on sources which The Northern Trust Company believes to be reliable, but we cannot warrant its accuracy or completeness. Such information is subject to change and is not intended to influence your investment decisions.

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