Orlando's Outlook: Huge trade drag hurts Q4 GDP

01-27-2017

Bottom line The Commerce Department flashed a weaker-than-expected fourth-quarter GDP gain of only 1.9% this morning, down sharply from the third quarter’s more robust pace of 3.5%. Both the Bloomberg and Blue Chip consensus estimates were at 2.2%, we had a more constructive 2.5% estimate here at Federated, and the Atlanta Fed’s widely-followed GDPNow estimate was at a much more aggressive 2.9%. For the full year 2016, GDP growth was 1.6%, which was our forecast, versus 2.6% in 2015.

The problem in the fourth quarter came from the largest drag from trade in six years, as a widening trade gap reduced GDP by 1.7 percentage points, in part due to the unwinding of the unsustainable surge in soybean exports to China in the third quarter. Aside from trade, however, other key categories contributed positively to growth. True, consumer spending was sequentially softer than in the third quarter, but inventory restocking, corporate capital expenditures (capex), housing and government spending were all stronger. If we exclude net trade and inventories—two of the most volatile components—from this fourth-quarter GDP flash, then domestic final sales grew 2.5% versus only 2.1% in the third quarter, which provides us with a clearer trend for underlying domestic demand.

Here are the key details regarding today’s fourth-quarter GDP flash report:

Soft consumer spending Personal consumption expenditures, which account for 70% of GDP, rose an in-line 2.5% in the fourth quarter, versus a stronger gain of 3% in the third quarter and a much more robust 4.3% increase in the second quarter, which was the largest quarterly increase since the fourth quarter of 2014. This contributed 1.7 percentage points to overall fourth-quarter GDP growth, compared with 2.03 and 2.88 percentage points in the third and second quarters of 2016, respectively. We were anticipating some sequential softness in personal consumption, given our expectations for only moderate levels of spending during the Christmas holiday.

Net trade taketh away The trade deficit widened in the fourth quarter by the largest amount since the second quarter of 2010, subtracting 1.7 percentage points from GDP growth and effectively negating the growth benefit from personal consumption. Exports fell 4.3% in the fourth quarter, which subtracted 0.53 percentage points. That compares with an unsustainable 10% third-quarter surge in exports, which added 1.16 percentage points. More precisely, goods exports fell 6.9% in the fourth quarter (subtracting 0.57 percentage points), while goods exports (which includes the massive soybean shipments to China) soared 14.4% in the third quarter, adding 1.08 percentage points. As a measure of comparison, in a much more typical second quarter, exports rose 1.8%, adding 0.21 basis points, as goods exports enjoyed a modest gain of 1.7% and added 0.13 percentage points. Because of the strong dollar, imports soared 8.3% in the fourth quarter, subtracting 1.17 percentage points, compared with a more modest 2.2% increase that subtracted 0.31 percentage points in the third quarter.

Housing strong Residential investment rose for the first time in three quarters, soaring 10.2% in the fourth quarter, which added 0.37 percentage points to GDP growth, the sector’s strongest contribution in a year. That compares with declines of 4.1% in the third quarter and 7.7% in the second quarter—the largest quarterly decline since the third quarter of 2010—which reduced GDP by 0.16 and 0.31 percentage points, respectively. With the recent spike in interest rates and winter now upon us, we expect housing growth to pause at least until the spring.

Inventory rebuild accelerates The new inventory-restocking cycle we’ve been forecasting commenced in the third quarter and began to accelerate in the fourth quarter, as businesses increased inventories by $48.7 billion, which added a percentage point to GDP growth, the most since the first quarter of 2015. By comparison, in the third quarter, we added $7.1 billion, which added 0.49 percentage points. The trough of the inventory liquidation cycle occurred in the second quarter, with an outright reduction in inventories of $9.5 billion—the most since the third quarter of 2011—which subtracted 1.16 percentage points from second-quarter GDP growth. Companies had been gutting bloated inventories amid a decelerating economy over the previous 18 months, from the peak addition of $114.4 billion in the first quarter of 2015. That reduction in inventory accumulation contributed to slower GDP growth for five consecutive quarters, the longest such period in almost six decades. But with the change in leadership in Washington, we expect a more business-friendly set of fiscal policies to stimulate faster inventory accumulation amid stronger economic growth.

Government spending rises again Total government spending, which accounts for about 17% of total GDP, rose 1.2% in the fourth quarter, adding 0.21 percentage points to GDP growth. That compares with the third quarter, in which government spending increased 0.8%, adding 0.14 percentage points, and a second-quarter decline of 1.7%, which subtracted 0.30 percentage points, the most in two years. Digging into the mix shift, federal government spending declined 1.2% in the fourth quarter, paced by a 3.6% decline in defense spending, while state and local spending collectively rose 2.6%.

Corporate capex rises Real business fixed investment rose for the third consecutive quarter by 2.4% in the third quarter, which added 0.30 percentage points to fourth-quarter GDP, the most in five quarters. That compares with gains of 1.4% and 1% in the third and second quarters, respectively. Looking at the key components, business equipment and software rose for the first time in five quarters, gaining 3.1% and adding 0.18 percentage points. That compares with declines of 4.5% and 2.9% in the third and second quarters, respectively. But business structure investment—a very volatile category that includes factories and office buildings—fell 5% in the fourth quarter, subtracting 0.14 percentage points, after surging 12% in the third quarter and falling 2.1% in the second quarter. Steady-as-she-goes intellectual property spending rose 6.4% in the fourth quarter, which added 0.26 percentage points, compared with gains of 3.2% in the third quarter and 9.0% in the second quarter. We similarly expect corporate capex investment to accelerate under the Trump administration.

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