The Oil Drum

Economists React
January 27, 2006 11:17 a.m.
After the economy navigated a brutal hurricane season to post robust growth in the third quarter of 2005, growth cooled considerably in the fourth quarter. Gross domestic product, the broadest measure of U.S. economic output, increased at just a 1.1% seasonally adjusted annual rate as free-spending consumers became more cautious and the gaping trade deficit continued to provide a drag on the expansion. For all of 2005, GDP growth averaged a 3.5% annual rate. What does the slowdown in the fourth quarter mean for the economy in the months ahead? Economists weigh in with their reactions:

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In both its overall appearance and underlying detail, the 1.1% fourth quarter growth in real GDP ranks as the most perplexing report in memory. At face value, such weakness would seem to make it more difficult for the Fed to tighten monetary policy again. But the underlying details reinforce -- if not increase -- perceptions that much faster growth lies ahead. Nonetheless, the confusing and conflicting contradictions with other data make it difficult to be confident in any inferences about the outlook.
-- David Resler and Gerald Zukowski, Nomura Securities International

Consumer spending was actually a little better than expected, rising by 1.1% in the quarter vs. our forecast of +0.3%. I think more of the decline in auto sales was apportioned to the business sector (fleet sales) and less to the retail side than we expected. Housing posted a reasonable gain of 3.5%, but this was less than half of our assumed rise. The monthly source data pointed to a bigger gain, so this is a bit puzzling.
-- Stephen Stanley, RBS Greenwich Capital

The consensus was a bit optimistic but this is a big surprise. The softness against our 2.6% forecast is explained by two components, fixed investment and government consumption. The former rose only 3.0%, with equipment and software up only 3.5%. This is baffling, given the 19.5% annualized leap in the value of capital goods production and the 14.9% rise in shipments of core nondefense capital goods. We expect big upward revisions.
-- Ian Shepherdson, High Frequency Economics

While this was a disappointing report, there are signs of a very sharp rebound in GDP growth in the current quarter. First, much of the miss in fourth-quarter inventories is likely to spill over to the first quarter. Second, at least a partial rebound in defense appears likely. Finally, the ramp for consumption spending is even more favorable in the aftermath of the fourth quarter data. The bottom line is that we now see a very good possibility of 5%+ GDP growth in Q1 -- versus our prior estimate of +4.2%.
-- David Greenlaw and Ted Wieseman, Morgan Stanley

This report is the worst case scenario for the Fed and Mr. Bernanke and the new Fed Chair will be tested right off the bat. The economy is slowing, though clearly not as rapidly as the headline number would have you think. But growth rates in the 2.5% to 3% range should be expected. At the same time, inflation is slowly accelerating. The fourth quarter rate was above the FOMC's previously projected pace. With energy costs up, the Fed has to be concerned about inflation. I cannot see the term tame being used in the next statement.
-- Joel L. Naroff, Naroff Economic Advisors

The only thing that kept GDP growth positive at all was a massive build-up in inventories -- the largest increase in inventories since early 2002. Apparently businesses were caught off guard by the slowdown in demand, and have not yet slowed their production accordingly. Presumably, they will. All in all, this is an extremely worrying report. I've been bearish about economic growth in 2006 for a little while now, and this has just confirmed my worst fears.
-- Kash Mansori, Colby College

With vehicle sales now recovering, consumer and capital spending, as well as GDP activity, will be stronger in Q1. With inventories still very low compared to sales, inventory rebuilding could significantly strengthen Q1 growth. The underlying economy remained solid at year end, despite high energy prices, rising interest rates, and slumping vehicle sales. The Federal Reserve will still tighten next week and probably again in March.
-- Steven Wood, Insight Economics

Wall Street pundits will again try to spin the GDP numbers into a positive, but I believe that this is the beginning of an inevitable recession. ... In the future, those that can afford to pay the additional amount on their higher mortgage will have to "tighten their belt" and not spend as much money in the economy. Consequently, they will hold on to their car a couple of years longer, not frequent their local restaurant as often, and cut back on their overall spending.
-- Emanuel Balarie, Wisdom Financial

Growth will rebound in the first quarter. Car sales are expected to bounce back. Most companies will see little need to liquidate inventories. Defense spending will probably grow again. Also, because the fundamentals for capital spending and export growth are strong, we predict acceleration of growth for both categories of spending in this quarter.
-- Nariman Behravesh, Global Insight

Yesterday's durable goods orders data suggested a lumpy capital spending environment, but one that has improved more than the 4Q GDP data today suggest. Unit auto sales might never eclipse their Summer 2005 level for a very long time to come. However, unit sales in early 2006 appear to be above the 4Q 2005 level, and will make a positive contribution to consumption in 1Q. Most assuredly, government outlays are unlikely to shrink in the coming quarter. While we don't expect an reacceleration in trend demand in 2006, today's GDP data really seem to undercount current growth, and a 1Q 2006 rebound in measured GDP is quite likely.
-- Steven Wieting, Citigroup

With the housing market topping off, if not actually declining, growth is likely to be substantially lower in 2006 than most economists have projected. While the economy is currently experiencing healthy job and wage growth, the falloff in borrowing against home equity will depress consumption growth. Furthermore, wage growth is likely to spur the market's fears of inflation (especially in a context of slowing productivity growth). This would push mortgage interest rates higher, further depressing housing prices and residential construction. It is still too early to say that the housing bubble is deflating, but the evidence is certainly growing that the process may have begun.
-- Dean Baker, Center for Economic and Policy Research

This retrenchment in spending was generally foreseen, though economists weren't sure on the timing and magnitude. American shoppers have been the main engine of growth for the US and the international economy the last few years. But in the process, they have been spending far more than what they earned. All told, household debt has been increasing at an annual pace of nearly 12% in the latest quarter, the fastest pace in 18 years.
-- Bernard Baumohl, The Economic Outlook Group

We view the fourth quarter slowdown as a temporary development, one that reflected (1) influences of the August-September hurricanes and (2) ahuge swing in vehicle sales between 3Q and 4Q due to incentives. Indeed,vehicle sales were a big drag not only on consumption, but also on equipment investment. We do not believe this report will have a measurable bearing on Fed policy, especially with high frequency indicators from 1Q pointing to strong growth. The expectation is for the funds rate to rise to 5.0% by the May meeting.
-- Haseeb Ahmed, J.P. Morgan Chase