The second quarter GDP report, while not a blockbuster by any measure, will nudge the Fed further in the direction of a September rate hike. At first blush this might seem preposterous - 2.3% growth is nothing to write home about in comparison to history. But history is deceiving in this case. It remains important to keep in mind that 2% is the new 4%.
Year-over-year growth rates continue to hover around 2.5%:
While the 2.3% quarterly rate of the second quarter was below consensus forecasts, the first quarter figure was revised up from -0.2% to 0.6%. That said, the annual revisions from 2012-2014 disappointed. Average annual growth from 2011 to 2014 dropped from a previsouly reported 2.3% to 2.0%. Sad, very sad.
That was still enough growth, however, to sustain fairly solid job growth and sharp declines in the unemployment rate, suggesting that potential output growth is indeed fairly anemic. The Fed staff appear to agree; see their very low potential growth numbers in the accidentally released forecasts (and for more on the implications of those forecasts, see Gavin Davies). Note also the low end of the range of potential growth estimates from FOMC meeting participants is 1.8%. Furthermore, San Francisco Federal Reserve President John Williams wants the Fed to guide the economy to a 2.0% growth rate in 2016. Hence 2.3% growth when the economy is operating near full-employment is sufficient for many policymakers to pull the trigger on the first rate hike.
A second implication of the revisions is that they provide no relief for those pondering low productivity growth. Indeed, it is quite the opposite, and they suggest downward revisions to productivity. Low productivity plus low labor force growth equals low potential output growth. 2% is the new 4%. And don't expect that all the data will fall into the same nice, consistent patterns we typically see in a business cycle. Some indicators will point up, others down, leading to many erroneous calls that a recession is soon upon us.
As an aside, solid research and development spending gives hope that productivity growth will accelerate:
We can only wait and see.
The inflation numbers also point to a September hike. Recall that the Fed is waiting until they are reasonably confident that inflation is heading back to target. Headline and core PCE rebounded to 2.15% and 1.81% annual growth rates in the first quarter, respectively, adding weight to the Fed's conviction that the inflation weakness of the first half was indeed transitory. To be sure, these gains have yet to translate into higher year-over-year numbers. But a forward looking Fed will expect they will head higher.
Separately, the forward-looking indicator of initial unemployment claims continues to hover at very low levels:
A reminder that layoffs are few and far between as we head into next week's employment report for July.
Bottom Line: An unspectacular recovery, but sufficient to keep the Fed on track for raising rates this year. The case for September further strengthens.
