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Thursday, August 29, 2013

The picture emerging from this morning's data is broadly positive, with both GDP growth and labor market improvement moving in the right direction. If the Fed is looking only at economic data, then these and the many others coming out next week are good enough for the Taper process to get underway sooner rather than later. But many have started hoping that the Fed may rethink its timeline given the coming debt ceiling fight in Congress and the changing geostrategic backdrop given developments in the Middle East.

The second read on Q2 GDP came in better than expected, with the economy growing at +2.5% pace instead of the +1.7% that was reported a month back. The positive revision resulted from improved international trade contribution and modestly higher business spending, partly offset by a greater decline in government spending than originally estimated. The all-important consumer spending numbers remained unchanged at +1.8% from the first look at Q2 GDP growth.

Exports were up +8.6% in Q2 instead of +5.4% reported the first time around, with all of the gains coming from goods exports. Imports were up less than originally estimated (up +7% vs. +9.5%), potentially pointing towards demand weakness, particularly when read in combination with the lack of positive revision to consumer spending.
 
Job gains and wage growth are the primary drivers that fuel consumption growth, the mainstay of the U.S. economy. But while job growth has been decent enough, as this morning’s weekly Jobless Claims data reconfirms, wage growth has been firmly held down. The recent spike in oil prices due to developments in the Middle East, if sustained over the coming months, could potentially become another headwind for consumer spending and as a result GDP growth. That said, it is reasonable to assume that the U.S. economy has enough growth momentum to sustain GDP growth of at least +2% in the coming quarters.

But many are hoping that the GDP growth pace ramps up to +3% and higher later this year and next. This growth outlook underpins the ‘Taper’ talk. As long as the economy is moving in that direction, which it is at present, then we should expect the Fed to move towards pulling back on the QE program. The announcement will most likely come in the Fed’s September meeting. But as indicated earlier, the debt ceiling uncertainty and the prospect of another conflict in the Middle East may prompt the Fed to delay the announcement by a month or two. But irrespective of whether the Taper is coming in September or later, nobody questions that it is on its way.

Sheraz Mian
Director of Research

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