GDP UPDATE
July 2009
McIlvaine Company
TABLE OF CONTENTS
The U.S. economy just went through its worst two quarters in more than 60 years, as businesses reduced their investments at the fastest pace since the Depression, according to the Commerce Department as it revised its estimate for first-quarter gross domestic product.
Real GDP -- the measure of the value of goods and services produced in the economy -- fell at a 5.5% annual rate in the quarter after plunging at a 6.3% pace in the fourth quarter of 2008, the government said. A month ago, the government had estimated GDP fell at a 5.7% pace in the January-through-March quarter. The government revises the estimates as it obtains more complete data not available earlier.
Economists surveyed by MarketWatch were forecasting that the final estimate for first quarter GDP would be unchanged at a negative 5.7%. They expect the economy to contract 1.5% annualized in the second quarter (which ends next week) and to grow 1.3% in the quarter that begins July 1.
The Federal Reserve said the pace of economic contraction was slowing, but cautioned that the economy would remain weak for some time.
The GDP revisions were largely trivial and don't alter the big picture of an economic calamity in the six months following the collapse of Lehman Bros. The main changes in the report were higher inventories and lower imports than previously estimated. Consumer spending, business investment, residential investments, and exports were revised lower. Business investment declined at a record rate during the quarter. Investments in housing fell at the fastest pace in 29 years. Domestic demand fell at the fastest rate in 29 years. Exports fell at the fastest pace in 40 years, while imports fell at the fastest pace in 62 years.
The big story for the first quarter was in the business sector, where firms stopped new investments, and shed workers and inventories at a dizzying pace to bring down production and stockpiles to match the lower demand from U.S. and foreign markets.
Much of the contraction in the economy was due to unprecedented inventory liquidation by businesses. Falling inventories subtracted from GDP in the first quarter, but that liquidation will set the stage for stronger growth later after companies have brought supply back in line with demand.
The swing in the inventory cycle from being a massive drag to being a small help is the main reason economists expect the economy to begin to grow again in the third or fourth quarters. That growth won't be sustainable, however, unless consumer and business demand picks up, both here and abroad.
Final demand was extremely weak in the first quarter. U.S. residents' purchases of goods and services (regardless of country of origin) dropped 7.5% annualized, the largest decline since 1980. Final sales of U.S. goods and services fell at a 3.3% annual rate. Final domestic sales of U.S. goods and services fell 5.4%. Exports fell at 30.6% annual rate, the most in 40 years, as foreign markets fell into a deep recession.
The two-quarter contraction is the worst in more than 60 years. Since 1947, the economy had never contracted by more than 5% for two consecutive quarters. With a 0.5% drop in the third quarter of 2008, it's the first time the economy has contracted for three consecutive quarters since 1975. In the past four quarters, the economy has fallen 2.5%, the biggest year-over-year decline since 1982.
Although the decline in GDP in the first quarter was nearly as deep as in the fourth quarter, the report was more varied in tone, with some positives mixed with some record-setting declines.
In a separate report, the Labor Department said first-time claims for unemployment benefits rose by 15,000 to 627,000. The number of continuing claims rose by 29,000 to 6.74 million.
The price index for domestic purchases (prices paid by U.S. residents) fell 1% in the quarter on lower energy costs. Consumer prices fell 0.9%, while core consumer prices (which exclude food and energy) rose 1.6%. In current dollar terms, GDP fell 2.9% to an annual rate of $14.1 trillion.
Corporate profits from current production rose 3.8%, or $48.1 billion, compared with the fourth quarter when they fell by $250 billion, or 16.5%. It was the largest quarter-to-quarter gain in profits in three years.
However, all of the profits accrued to the financial sector, which profited from very low borrowing costs as the Federal Reserve struggled to keep the banks alive. Domestic non-financial corporations saw their profits fall by $49 billion after they fell by $89.1 billion in the fourth quarter. Over the past year, before-tax profits are down 17.6%. After-tax profits are down 14.7%.
Final sales, which exclude inventories, fell at a 3.3% rate in the first quarter after plunging 6.2% in the fourth quarter. Consumer spending rebounded to rise 1.4% after dropping at a 4% annual pace in the previous two quarters. Consumer spending added 1 percentage points to GDP.
Spending on durable goods rose 9.5%, and spending on nondurable goods fell 0.4% as spending on food fell for the third straight quarter. Spending on services increased 0.9%. Despite the bump in spending, the savings rate rose to 4.3% as real disposable income rose 6%.
Business investments fell at a record 37.3% annual rate in the first quarter. Investments in structures dropped a record 42.9%, and investments in equipment and software fell at a 33.7% pace, the biggest drop since 1958. Business fixed investment subtracted 4.6 percentage points from growth.
Inventories declined by $87.1 billion. The change in inventories subtracted 2.2 percentage points from growth.
Investments in housing fell for the 13th consecutive quarter, dropping at a 38.8% annual rate, the largest decline since 1980. Residential investments subtracted 1.4 percentage points from growth.
Trade collapsed during the quarter. Exports fell 30.6%, the most in 40 years, reflecting the global recession that has hit Europe, Japan and other trading partners even harder than the United States. Imports dropped 36.4%, the most in 62 years, as U.S. consumers and businesses stopped buying. Net exports added 2.4 percentage points to growth, however, as the trade gap narrowed.
Government spending fell at a 3.1% annual pace, the largest drop in 13 years. Spending by state and local governments fell 2.2%, the most since 2001. Federal spending fell 4.5%, including a 6.8% drop in the volatile defense spending category. Government spending subtracted 0.6 percentage points from growth.
Brazil’s economy may contract less than previously expected this year, raising speculation policy makers may pause after cutting interest rates for a fifth straight time next week.
Economists covering Brazil’s economy predict gross domestic product will shrink 0.34% in 2009, compared with a forecast for a 0.50% drop a week earlier, according to the median forecast in a July 10 central bank survey of about 100 economists. The central bank will cut the so-called Selic rate to a record 8.75% on July 22 and hold it at that level through year-end, the survey showed.
“The economy has proven more resilient than expected, leading to a little more caution by policy makers,” Roberto Padovani, chief economist at Banco WestLB in Sao Paulo, said in a telephone interview. “We also see inflation in Brazil has a certain resistance.”
Economists expect annual inflation will slow to 4.5% by year-end from the current 4.80%, survey showed. Previously, economists expected a year-end annual rate of 4.42%. Policy makers target an annual inflation rate of 4.50%, plus or minus two percentage points to accommodate for unexpected price shocks.
The International Monetary Fund revised forecasts for the Canadian economy, predicting output this year will contract a little less than it had expected three months ago, and rebound faster in 2010. The IMF's update to its World Economic Report forecast Canada's gross domestic product to shrink 2.3% in 2009, and grow 1.6% in 2010.
In April, the IMF had forecast GDP to contract 2.5% this year and grow 1.2% in 2010. The IMF's revised forecast for next year is the same as its prediction from January before the figure was downgraded three months later.
Chilean inflation will likely end 2009 at 0.0%, down from 7.1% in 2008, while the gross domestic product will likely contract 1.5%, according to the median forecast of 33 local analysts in the central bank's monthly economic outlook survey.
Analysts' expectations fell from last month's poll, when they saw 0.2% inflation for the year and expected GDP to contract 1.0%.
For the third quarter of 2009, analysts expect GDP to contract 1.7% on the year, according to the poll. In last month's poll, analysts saw a 3.0% second quarter contraction.
The economy began the year on negative ground, with GDP contracting 2.1% on the year in the first quarter and economic activity falling 4.4% in May, according to the central bank's Imacec monthly economic activity index. The Imacec index is considered a proxy for the country's gross domestic product because it encompasses 90% of the components in the GDP.
For June, analysts see the Imacec contracting 3.6% on the year, according to the poll.
The central bank expects inflation to fall to 0.6% this year and GDP in a range of -0.75% to +0.25% with a bias toward the weaker end of the range, according to the bank's most recent four-month Monetary Policy Report.
As for monetary policy, analysts expect the central bank to cut the key interest rate, known as TPM, 25 basis points to a record low 0.5% when it holds its monthly monetary policy meeting later in the day, according to the poll's median estimate. The TPM should then hold at 0.5% for the remainder of the year, according the poll.
During the first six months of the year, the central bank slashed the key rate a total of 750 basis points, bringing it to 0.75% from 8.25% in December 2008.
Mexico's economy could expand next year by even more than the "close to 3%" forecast by the government, and the Bank of Mexico is near the end of its rate-cutting cycle, Guillermo Ortiz, governor of the Mexican central bank, told journalists recently.
Asked whether comments by Mexican Finance Minister Agustin Carstens that gross domestic product could expand by "close to 3%" next year seemed realistic, Ortiz said: "I wouldn't be surprised if 2010 growth was higher."
Speaking on the sidelines of a financial sector conference, Ortiz said much will depend on what happens with the U.S. economy, but that the Mexican economy will be starting from a low base next year after a sharp fall this year.
"There is an arithmetic effect...when the fall is deep, the rebound is also swift," he said.
Private economists surveyed in June by the Bank of Mexico said they expect Mexican GDP to contract 6.3% this year.
On interest rates, Ortiz reiterated the Bank of Mexico's recent statements that its rate-cutting cycle is nearing its end.
"Future actions will have to take into account the output gap, the economic situation, as well as inflation prospects," Ortiz said.
China’s economic growth may have accelerated to as much as 7.5% in the second quarter on surging fixed-asset investment and loans, said Zhang Jianhua, head of the central bank’s research bureau.
“Despite a global economic contraction and some uncertainties over growth in domestic demand, China’s economic recovery will continue,” Zhang said. His comments were in an edition of the central bank’s China Finance magazine.
China’s economy may expand 8% in the third quarter and 9% in the final three months of the year, driven by government spending and growth in money supply, he said.
A 4 trillion yuan ($585 billion) stimulus package is reviving the world’s third-biggest economy after exports collapsed and growth slowed to the weakest pace in almost a decade. President Hu Jintao said that the economy “has stabilized.”
Gross domestic product rose 6.1% in the first quarter from a year earlier.
China’s GDP climbed 13% in 2007 and 9% last year. Zhang sees annual expansions of about 8% from 2010 as the global economy grows at a weaker pace than before the financial crisis, curtailing export demand. Overcapacity in Chinese industries may also limit investment, he said.
Policy makers don’t need to make ‘drastic” adjustments to monetary policy, Zhang said, adding that some “fine-tuning” is necessary to prevent asset bubbles, bad-loan risks and a return to high inflation.
China may face a greater inflationary risk in the first half of next year, Zhang said.
Goldman Sachs Group Inc. raised its forecast for South Korea’s gross domestic product in 2009, citing stimulus from government spending and interest-rate cuts coupled with a pickup in exports. The economy will contract 1.7% this year, less than a 3% decline previously predicted, Goldman economist Goohoon Kwon said in a report. Kwon lowered the estimate for economic growth in 2010 to 2.7% from 2.9%.
“The economy is recovering faster than we expected thanks to a good mix of strong fiscal stimulus, a weak Korean won and monetary easing,” the Hong Kong-based economist wrote. “The second-half recovery will likely come mainly from a pickup in exports of consumer cyclicals.”
The International Monetary Fund yesterday raised its forecast for the nation’s GDP, saying the central bank should leave interest rates unchanged and the government should maintain its fiscal stimulus through 2010. South Korea authorities have pledged more than 67 trillion won ($53 billion) in spending measures over the past year and also set up funds to replenish lenders’ capital and buy distressed assets.
Goldman’s Kwon expects the Bank of Korea to keep borrowing costs unchanged for the rest of the year, after previously predicting another reduction. The central bank cut its benchmark rate by 3.25 percentage points between October and February to a record-low 2 percent.
A rate increase could come “as early as in the first quarter of 2010 but the tightening cycle will likely be slow and moderate due to a weak global recovery and high household debts,” Kwon said.
All 15 economists surveyed by Bloomberg News expect the central bank to leave policy unchanged at tomorrow’s meeting.
Exports, which are equivalent to about half of GDP, climbed 17% in June from the previous month to the highest level since October and factory production rose for a fifth month in May from April, reports last week showed.
Euro-zone economic and inflation prospects remain subdued due to a depressed outlook for company earnings and restricted credit access, three European think-tanks led by Germany's Ifo predicted.
"Economic prospects remain subdued, but the contraction of activity is likely to be less sharp in the coming quarters," Ifo, Italy's ISAE and France's INSEE said in a joint press release. "The fall of industrial production is likely to continue but at a progressively slowing pace: recent business surveys indicate slightly improving production growth expectations, but the economic environment remains unsupportive."
Aggregate real gross domestic product for the 16 countries using the euro is forecast to shrink 0.6% in the second quarter and 0.4% in the third quarter. In the three months to Dec. 31, the institutes predict euro-Zone GDP to shrink 0.4%, reflecting a full-year forecast of a 4.8% GDP decline in 2009.
"Firms' earning prospects are still depressed and credit conditions are likely to remain restrictive due to recession caused write-offs," the institutes said.
Euro-zone consumer prices clearly will be rising again at the end of the year, the institutes said.
"On the assumption that the oil price stabilizes at $70 per barrel of Brent and that the dollar/euro exchange rate fluctuates around $1.40 over the forecast horizon, inflation should move to -0.1% in September and 1.0% in December," the institutes said.
Croatia's government recently presented budget cuts to fight the financial crisis and announced more tough savings soon, insisting the country won't need to call in the International Monetary Fund for help.
The government cut budget spending for this year by nearly 800 million kuna ($152.35 million) and redistributed another 2.2 billion kuna ($419 million) of expenditures in the second budget revision this year. Parliament will vote on it soon. Prime Minister Jadranka Kosor said more cuts will still be necessary soon.
"We will have to make another step," she told the Cabinet, announcing that she expected the lawmakers to gather at an extraordinary session during the summer holidays to vote on the third, tougher budget revision.
Kosor, who took up the post last week as the country faces its worst economic outlook since the 1991 war, said the savings stretch from cuts in state officials' wages and spending to canceling free textbooks and transport for pupils.
The government forecast its gross domestic product to contract by 4.5% this year.
Croatia recently acknowledged that the country is facing economic troubles, as revenues plunged. The country's GDP fell 6.7% in the first quarter — the biggest drop in 10 years. Tourism, which is Croatia's main source of foreign currency, will likely fail because of the global economic downturn. Some economic analysts suggested that the country will have to seek IMF assistance, as did a number of east European countries.
But Finance Minister Ivan Suker insisted that won't be needed. The IMF will require savings in public spending in return, "and we can make those painful moves ourselves."
Suker also insisted that the former Yugoslav country of 4.5 million, which joined NATO this year and hopes to join the European Union in the near future, "is not facing bankruptcy or financial collapse."
With the next budget cuts later in the summer, the deficit should lower to 1% of GDP, he said.
A record number of Czech companies filed for bankruptcy in the first half of 2009, research by credit agency Creditreform has shown. Czech export-oriented firms are suffering as demand for their mainly industrial goods such as vehicles and steel products has fallen by almost a quarter due to the evaporation of orders from the recession-hit euro zone.
Another problem is stricter bank lending rules, which has severely cut the flows of credit to companies. In June, a study by Czech Chamber of Commerce unveiled 76 percent of firms had to cut production due to a lack of financing. In the first half of this year, 4,021 companies filed for bankruptcy, far above the 2,551 filings in the same period a year ago, the research showed. June saw a total of 891 filings, the highest number of petitions submitted within a single month.
"It can be expected that by the end of August the number of filed corporate bankruptcy proposals will equal the number for the whole of 2008," the credit agency said.
A total of 5,359 institutions filed for bankruptcy in 2008, Creditreform said.
From the filings received in the January-June period 1,591 companies had been declared bankrupt so far. More than half of the submissions were rejected because the companies had no assets to distribute among creditors.
First quarter GDP shrank by a record 3.4% year on year and a poor industrial output reading pointed to expectations for another miserable quarter.
Finland's gross domestic product (GDP) fell 9.2% in April from the previous year, Statistics Finland has said, with building and manufacturing the hardest hit. However, the statistics office revised its March GDP figures to an 8.2% decline from a previously reported 10.8% fall, making the overall data look slightly less bearish.
The main reasons for revisions in the March data were benchmarks to quarterly accounts and upwards revisions in industry data, especially in manufacturing and other services, the statistics agency said in the statement.
The April data showed production in construction and manufacturing -- key contributors to the Finnish economy -- was down around 17 percent year-on-year. Overall production in April slid 0.6% from the previous month. Output in agriculture and forestry showed slight growth on an annual basis of just below two percent, while services fell six percent.
StorySampo Bank economist Lauri Uotila said the GDP figures were better than expected.
'Though data has now been corrected ... it shows that the steep decline of the first half-year continues,' Uotila said, adding that while he expected a big decline in May, the data supported expectations that the economic downturn may ease in the second half of the year.
'It's a rough downwards ride, but things will hopefully look slightly better at the end of the year,' he said.
The Duesseldorf-based Institute for Macroeconomy and Economic Research, or IMK, recently cut its estimates for German growth this year and next and warned that no real turnaround will happen even in 2010. The IMK, one of a group of economic research institutes retained by the government as a permanent adviser, said the economy will contract by 6.5% this year and by 0.4% next year. In its previous report in March, it had projected growth of 0.2% for 2010, after a 5% contraction in 2009.
"Thanks to the state stabilization policies, the situation will calm down in 2010, but there will be no turnaround for the better," IMK director Gustav Horn said in a report.
The institute said the collapse of world demand for German goods was largely responsible for the gloomy overall picture. It said it expects exports to fall 17.8% this year, in turn contributing to a 10.7% decline in investment in fixed assets. For 2010, it expects investment to continue to fall, albeit at a much slower rate of 0.3%. It expects exports to rise by 0.3%.
The institute urged both the German government and others in the euro area to expand their stimulus programs in the short term.
"If we don't do more, the German economy will stay in a trough for longer and unemployment will continue to rise drastically," Horn said.
The institute painted a slightly more positive picture for domestic demand, which it said will rise 0.2% this year due to government stimulus measures. Some of these, such as the scheme to encourage scrapping old cars, will be ended later this year.
However, IMK said it expected a sharp rise in unemployment toward the end of 2009, extending into 2010 and contributing to an overall decline of 1.4% in domestic demand. IMK expects the total of jobless to hit 4.7 million by the end of 2010, and to average 4.448 million over the whole year, after averaging 3.575 million in 2009. As a result, it expects the budget deficit to widen to 6.4% of gross domestic product in 2010 from 4% of GDP this year.
Spain's economy is likely to have shrunk 'substantially' less in the second quarter than in the first, though growth will remain negative to the end of the year, the economy secretary said recently.
“We don't have a precise estimate, but we believe that the fall (in gross domestic product) will be substantially less than in the first quarter,' Jose Manuel Campa said in an interview with the financial daily Cinco Dias. 'Until the end of the year we will continue to have negative growth rates, but increasingly smaller ones.' Spain's economy shrank 1.9% in the first quarter from a quarter earlier, its sharpest contraction in half a century.
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