The decline of 0.1 per cent in US real GDP in 2012 Q4 (at a seasonally adjusted annualised rate) is a definite negative surprise for financial market sentiment, which has become very complacent about the ability of the US economy to withstand the fiscal tightening due to hit the economy.
Fortunately, the underlying picture for final domestic demand is reassuring, which is why the markets have taken these figures in their stride. Today’s figures are unlikely to signal a serious downturn.
But the US economy almost never posts a negative quarter in the middle of a robust upswing, so the figures should give us some pause for thought. Furthermore, the weakness of exports, which is more than a one quarter phenomenon, shows that the global economy had become dangerously dependent on the strength of the US consumer towards the end of last year.
Here is the story in a series of graphs.
The growth rate of real GDP was about 1 per cent worse than expected, meaning that it moved fractionally into negative territory. This initial estimate is of course subject to future revision, but if it survives these revisions, it will be the first negative reading in the midst of a continuing recovery for quite a while. There was no negative reading in the long upswings of the 1990s and the 2000s:
The GDP figures would have been very alarming, if it were not for the fact that the main elements of final domestic demand showed no signs of weakness. Real consumers’ expenditure, responding to a firming labour market and falling price inflation, contributed +1.5 percentage points to the growth rate in the quarter:
Furthermore, and surprisingly in view of the concerns expressed on the confidence of the corporate sector about “policy uncertainty”, and the weakening in capital goods orders during Q3, private fixed investment bounced quite strongly during the quarter, contributing +1.2 percentage points to GDP growth. This does not support those who believe that the fiscal cliff has already weakened the economy:
However, there were three major factors that dragged down the economy in Q4, and two of these may have been related to the fiscal cliff.
First, there was a large drop in inventories, which subtracted 1.3 percentage points from the GDP growth rate. This is of course a very volatile series, and it is hard to tell whether the decline was due to a postponement of stockbuilding ahead of the fiscal uncertainties, or due to other wider weakness in the industrial sector. However, it is likely that this drag will be partially reversed in 2013 Q1, giving a boost to activity compared with the latest forecasts, which have been expecting Q1 GDP growth of about 1.5 per cent:
Second, there has been a very large and unexpected drop in defence spending (current defence, not capital spending), which has subtracted 1.3 percentage points from GDP growth in Q4. I have not seen a good explanation for this. One possibility is that the defence establishment has made some early economies in anticipation of the sequestration cuts that would be needed if current fiscal legislation goes ahead in March, in which case this would be an early warning of the fiscal retrenchment that could lie around the corner. The next graph shows government spending in the defence and non-defence sectors:
Third, and perhaps most worrying for its signal on the global economy, growth in US exports has been falling for several quarters, and has moved sharply into negative territory in Q4. Much of this seems to have come from weakness in sales to the eurozone, which is unlikely to reverse soon:
One last point. The weakness in GDP growth in the latest quarter has been accompanied by a very low reading for inflation, based either on the GDP deflator or on the deflator for private consumers’ expenditure, suggesting that the below trend growth in the economy may at last be having some effect on inflationary pressures:
In conclusion, this dip into negative territory is unlikely to be the precursor of a serious downturn in the US economy. The strengthening in the labour and housing markets are underpinning consumption, the rebound in corporate investment suggests that the confidence of company executives has not been much damaged by policy uncertainty, and inventories should rebound quickly.
However, there is some evidence that the fiscal tightening will be a drag on the economy for several quarters, and the weakness of the eurozone is now proving to be a significant negative factor. Growth will struggle to attain its 2.5 per cent trend rate in 2013. With price inflation remaining well below 2 per cent, there seems little case for the Fed to deviate from its current easing stance for now.
