Via Millan Mulraine at TDSecurities:
US: Economic Recovery Stuck in First Gear
· GDP advanced at a very paltry 1.2% q/q in Q2, disappointing the market consensus for a more robust 2.5% q/q advance.
· Consumer spending, however, was one of the bright spot of this report, though the buoyant spending performance was partially offset by weaker investment and trade activity.
· The overall tone of this report was quite weak, and when combined with the downward revisions to the prior estimates it points to a US economic recovery that is stuck in low gear.
· The ECI ticked modestly higher, up 0.56% q/q, though the annual pace of employment cost inflation accelerated to 2.3% y/y from 1.9% y/y on favorable base effects.
The US economy eked out a very meager 1.2% q/q advance in Q2. This was a far weaker performance than the above-trend 2.5% q/q advance expected by the markets. This disappointing performance follows and equally subpar 0.8% q/q gain in Q1, which was downwardly revised from +1.1% q/q. Despite the sticker shock on the headline number, the sharp acceleration in personal consumption activity, which rose at a robust 4.2% pace from 1.6%, points to strong underlying fundamentals underpinning the economic recovery. Final private domestic sales, a more objective measure of domestic economic strength, was quite constructive, rising at a very brisk 2.7% pace.
Outside of the sharp rise in PCE, which contributed a robust 2.8ppts to topline growth, the sharp decline in the other segments of the economy points to a very narrow platform for growth. In particular, investment activity was quite weak, as both fixed investment (subtracting 0.5ppt) and inventory investment (subtracting 1.2ppt) subtracted from growth, underscoring the continued sluggish performance in this segment of the US economy. Government spending was also a source of drag on economic activity, subtracting a further 0.16ppt from growth. Surprisingly, net trade added modestly to growth, bolstering the headline number by 0.23ppt, though this is likely to reverse in the coming months on account of the strong dollar and weaker global demand.
The historical benchmark revisions also added to the narrative of subdued growth, as sharp downward revisions to prior estimates point to an economic recovery that has been in far weaker shape than previously thought. For example, the Q2-2015 estimate was revised down from 3.9% q/q to 2.6% q/q, effectively signaling that the economy never really fully recovered from the Q1 weather hit. Since then, the economy is reported to have grown at a paltry 1.2% q/q average pace, essentially reflecting a stalled recovery. Note, however, the savings rate was revised sharply higher.
On the inflation front, the core PCE inflation rate decelerated to 1.7% y/y from 2.1 y/y. The ECI, however, rose at a respectable 0.56% q/q pace, with the annual pace of growth accelerating from 1.9% y/y to 2.3% y/y. Wage growth was a tad stronger, up 0.64% q/q and with the annual pace of wage growth accelerating to 2.5% y/y from 2.1% y/y.
The overall tone of this report was quite weak, and the hugely disappointing GDP performance in Q2 along with the big downward revisions to the prior quarters points to an economic recovery that is stuck in low gear. In particular, the below-trend pace of growth over the past year suggests that the level of economic slack is beginning to grow in the economy, which is likely to temper inflationary pressures further. To be sure, the sharp acceleration in personal consumption activity is a net positive for the economic recovery. However, this buoyant pace is unsustainable and the sharp rise in precautionary savings suggests that US consumers continue to be cautious in the face of continued global uncertainties. Furthermore, even though growth momentum is likely to rebound in the coming quarters, the potential for further headwinds to investment activity and the fallout from the strong dollar tempering growth suggests that any H2 bounce in activity will be very modest at best. For the Fed, this is hardly the environment in which they will want to consider raising rates. As such, we continue to feel comfortable about our expectation for the Fed to remain on the sideline until June next year as they continue to nurse the US economy back to full health.