Wednesday, June 26, 2013
The final revision to first quarter GDP growth is a bit of a shocker as these revisions typically don’t move that much. But given the fact that we are getting close to the end of the second quarter and will be getting the first look at Q2 GDP in a few week's time, today’s GDP report is nothing more than keeping the records straight. What we know after this morning’s GDP report is that the U.S. consumers and businesses spent a bit less and we imported less from abroad in Q1 than we thought initially.
The GDP report is no doubt disappointing, but it's not a big deal. The reason is that we care much more about what’s happening in the economy now and how we see the coming periods unfolding than what has happened in the past. And on that front, the picture is quite healthy.
Sentiment on the economic outlook has been improving, not just for later this year and next year, but also for current conditions. A steady stream of recent economic reports is showing that the budget sequester and tax rate changes from earlier this year have had a less dampening effect than earlier feared. Readings of consumer and business spending, confidence, jobs, and housing show plenty of resilience in the economy. And it is this resilience in the economy that is prompting the Fed to reach the conclusion that they could afford to reduce the level of monetary stimulus they have been providing.
Listening to Narayana Kocherlakota, the Minneapolis Fed President, on CNBC this morning confirmed my own assessment of the bond market’s reaction to last week’s Fed announcement. I have long been of the view that the market was looking at the ‘Taper’ issue as the starting point of an unwind process that will eventually culminate in the Fed raising the Fed Funds rate, the Fed’s primary monetary policy tool. The bond market is not jumping the gun by reaching that conclusion, but the reality is that the Fed’s decision on the Fed Funds rate issue will be data dependent and not driven by some artificial calendar.
The speed at which bond yields have adjusted surprised many in the market, Mr. Kocherlakota included. But he attributed part of the rise to the relatively improved economic outlook, with the rest a result of uncertainty about the Fed’s long-term plans. He is not a voting member of the FOMC, but his own economic outlook is for better second half 2013 GDP growth than the first half and further acceleration of the positive momentum in 2014. As such, he appears onboard with the Fed’s improved economic outlook for next year.
We will see how economic growth turns out in the second half of the year and next year. But if growth turns out to be as good as the Fed and consensus views are reflecting, then that is a far better backdrop for the stock market any QE from the Fed. Stock market investors may not be appreciative of this fact at present, but they will have to come around to that at some stage. Long accustomed to Fed support, adjustment to life without QE will neither be easy nor painless. But it is nevertheless a necessary and healthy process.
Director of Research