Q2 Real GDP Shockingly Weak

Today's shockingly weak Q216 GDP print underscores that US economic growth slowed sharply since last fall.   It argues against a September Fed rate hike.

          a.  The shockingly low 1.2% (q/q, saar) increase in Q216, after a downward-revised 0.8% in Q116, is the 3rd quarter in a row that Real GDP Growth was under 1.5%.   Real GDP Growth averaged a meager 1.0% over the Q415-Q216 period.

          b.  Prior to this, Real GDP Growth averaged 2.2% over the first 3 quarters of 2015 and 2.5% over 2014.

Much of the weakness since Q415 has been in business investment -- capital spending, oil drilling and, in Q216, inventory investment.   Besides the drag from the oil sector, businesses look to have been quite cautious about the outlook.

          a.  Some of the caution may have been in response to weak growth abroad and uncertainty about the upcoming Presidential election.   However, it also could have been in response to fears of Fed tightening ahead and to the implications of some of Obama's executive orders or agency rulings on items like net neutrality of the internet.   In any case, the slowdown coincided with both the Fed tightening through forward guidance and Obama's actions.

While some Street economists may argue that the Q2 GDP composition -- particularly the weak inventory investment -- bodes well for Q316 GDP, the reasons behind the Q216 weakness still exist.  Moreover, the strength of Consumer Spending in Q216 will probably not repeat itself in Q316.  So, another sub-2.0% GDP Growth Rate in Q316 may be in the cards.

The inflation side of the GDP report was benign and also argues against a September Fed rate hike.

         a.  The Core PCE Deflator slowed to 1.7% (q/q, saar) in Q216 from 2.1% in Q116.

         b.  The Market-Based Core PCE Deflator slowed to 1.6% from 1.8%.

         c.  While the Total PCE Deflator sped up to 1.9% from 0.3%, this was due to the jump in oil prices -- which have subsequently fallen sharply.
 
Even more disturbing than the below-expected print for Q2 Real GDP is the possibility that the near-1.0% pace may be near the potential growth rate.  This does not bode well for an improving trend in US standard of living.

         a.  The 1.0% average pace since Q416 has been associated with an essentially steady Unemployment Rate of around 5.0%.

The low Q216 print was a bad miss for the Fed's Nowcasting GDP Models.

         a.  These models had projected 2.2-2.4%, although the Atlanta Fed's model lowered its forecast to 1.8% yesterday after the Commerce Department released preliminary data for the June Trade Balance and Business Inventories.

         b.  One reason for the high estimates may be a problem with at least one of the proxies the models use for missing data.  In particular, the Atlanta Fed uses the Mfg ISM (total index and inventory component) to estimate Nonfarm Inventory Investment.  I have never found the Mfg ISM to be a reliable predictor of q/q changes in GDP or Nonfarm Inventory Investment.