Subject: Bridgewater Daily Observations - "Friday's GDP report highlighted the ongoing recovery in private sector demand ..."
Friday's GDP report highlighted the ongoing recovery in private sector demand and investment despite the fiscal drag and was roughly consistent with our overall picture of US growth running at about 2.5% in the first quarter. The private sector was stronger than the headline number as both personal spending and housing expanded at a healthy pace, while the overall report was weighed down by significant military spending cuts. Of course, the GDP report is a bit stale at this point, and more recently we are seeing some signs of a slight moderation in US growth. This cooling may continue as households adjust to higher taxes, business investment continues to slow, and the sequestration cuts flow through. That being said, the Fed continues to run very accommodative monetary policy, and households are increasingly able to respond to this stimulation, which has helped cushion some of the impact of the fiscal tightening. So overall, we don't expect growth to slow materially, with the potential for stronger growth rates later in the year as the fiscal drag fades.
Over the last six months, the US private sector has been expanding at a 3-3.5% pace, and of course, growth would likely have been even stronger without the hit to incomes from the fiscal tightening (both higher taxes and lower expenditures).
The ongoing expansion in private sector spending has taken place despite the increasing pullback from fiscal policy. Tax increases early this year are reducing household incomes and thus spending, while the impact of sequestration cuts will increase over the next several months.
Overall, our estimate is that the total fiscal drag will account for about 1.5% of GDP over the course of the first nine months of 2013 but will then likely fade late in the year and into 2014.
The GDP Report
The details of the GDP report corroborate our picture of the broader dynamics we've seen in other indications of US conditions:
* Household demand expanded at a healthy clip in the first quarter. This acceleration in spending has taken place even as pre-tax income growth rates remain mediocre, and despite a broad-based increase in taxes. Gradually healing balance sheets combined with ongoing significant monetary stimulation and rising asset prices have allowed households to absorb some of the fiscal hit via declining savings rates. That being said, household spending along with consumer confidence did slow some in March, as some
of the tax effects are now likely flowing through.
* Housing is now a moderate support to growth both through direct and indirect channels. Residential fixed investment has been expanding at an annualized pace of almost 15% for a year and a half now, and it was only a bit below that in the first quarter. However, housing construction only makes up about 2.5% of GOP now, so the overall impact on GOP was modest, at about 0.3%. Home sales and prices are also rising at a reasonable pace, so the indirect effects from housing are becoming increasingly supportive.
* Business investment was mediocre, expanding at a 2% annual pace in the first quarter, which is significantly slower than earlier in the expansion. The catch-up phase in business fixed investment is now behind us as spending levels are no longer depressed,
and at this point investment is likely to more closely track demand. While domestic sources of demand are relatively healthy, external sources have slowed in recent quarters.
* Government direct spending and investment is only one way in which fiscal policy impacts growth in the short term, but it has been a significant negative drag on the economy over the last three years. State and local governments were forced to cut back aggressively, military expenditures were pared back and federal spending growth stagnated. Government expenditures make up 18% of GOP and have contracted by 7% since peaking in late 2009. The pace of contraction was high in the first quarter, driven primarily by military cuts. All pieces of government expenditures have been weak in recent years, though state and local governments have been getting less weak while the federal government has become a larger direct drag.
* An increase in inventories created a modest +1 % boost to growth in the first quarter. This was an offset to the drop last quarter. At this point in the business cycle inventories should not have much of an impact over time.
* Trade was a drag on growth this quarter (-0.5%), consistent with US demand being healthier than external demand. Import growth was relatively strong at 5.4% while exports expanded by 2.9%. Of course, the strength in imports is reflective of healthy domestic demand even if it counts as a negative in GOP accounting.