4Q10 GDP: Back To The Drawing Board
Raymond James
By Scott Brown
February 1, 2011
The advance estimate of fourth quarter GDP growth was relatively close to expectations. However, two major components, net exports and the change in inventories, were much larger than anticipated (net exports added to GDP, slower inventory accumulation subtracted). Underlying domestic demand was roughly as anticipated, but the inventory story (assuming that it holds up in revisions) implies stronger growth in the near term. Instead of GDP growth of 3.0% to 3.5% in 2011 (4Q-over-4Q), it now appears more like 3.5% to 4.0%
As a rule, one should never get too worked up about the headline GDP figure. These data will be revised, and revised, and revised. However, the story typically doesn’t change much. Two of the choppiest GDP components, inventories and foreign trade, had huge impacts in 4Q10, but as it happened, these were in opposite directions. Inventory growth was high in 3Q10, clearly at an unsustainable pace. Remember, the change in inventories contributes to the level of GDP. So, the change in the change in inventories contributes to GDP growth. Slower inventory growth was expected to subtract from GDP growth after 3Q10. The surprise was that the drop came all in one quarter. Slower inventory growth shaved 3.7 percentage points from headline GDP (final sales, which excludes the change in inventories, rose at a 7.1% annual rate). Adjusting for inflation, the trade deficit shrank in 4Q10. Exports continued to improve, adding a full percentage point to GDP growth. Imports, which rose sharply in recent quarters, fell. Imports have a negative sign in the GDP calculation. Higher imports (a sign of strength in the domestic economy) subtracted from GDP growth in the first three quarters of 2010. In 4Q10, the drop in imports added 2.4 percentage points to GDP growth.
There are a number of anecdotal stories suggesting that many producers were caught short in the fourth quarter. Many bought into the double-dip scenario and curtailed production, only to find that demand was stronger than anticipated. The result is that inventories are generally lean. The GDP figures suggest that the inventory correction may have been excessive, in which case, there will be some increase in production in early 2011 (essentially, a correction to the over-correction).
The drop of imports is not a dollar story. Rather, it likely reflects the inventory reduction. Over the years, many U.S. producers have moved their inventory chains offshore. The rise in imports in the first three months of 2010 and the drop in 4Q10 is consistent with the inventory pattern. We should see imports pick up, which will subtract from GDP growth in early 2011. However, taken together, the inventory and import outlooks imply that GDP growth is likely to be somewhat higher in the first half of 2010 than was estimated earlier.
Consumer spending growth finished 2010 with a strong showing (a 4.4% annual rate), fueled partly by a drop in the savings rate (to 5.4%, from 5.9% in 3Q10). Real disposable income rose only 1.7% (following a 0.9% gain in 3Q10). However, disposable income will be boosted significantly in 1Q11 by the reduction in the employee-paid portion of payroll taxes. That should keep consumer spending growth strong. For a household earning $70,000 per year, the payroll tax reduction will add about $117 per month to take-home pay. A little of this will be eaten away by higher gasoline and healthcare costs, but there should be plenty left over. Unfortunately, payroll taxes are set to rebound in 2012. Hopefully, job growth will be strong enough to offset some of the negative impact.
As the Federal Open Market Committee indicated in the January 26 policy statement, the household sector continues to face a number of headwinds in the near term. The outlook for the first half of 2011 is a bit brighter. However, we need to see better job growth. That may arrive in the spring.
(c) Raymond James
