Monday, October 18, 2010

A Key Issue Regarding GDP Growth in Q3

Based on all available information to date, Q3 GDP growth looks like a 2% proposition, with the caveat that the international trade and inventory data for September are still not available (nor would they be by the time the advance GDP report is released on October 29. This incomplete information and associated assumptions that the Commerce Department will have to make have the potential to print a number that will be materially different next week.

The composition of third quarter GDP is of special importance here, as it is likely to have a direct bearing on the current quarter's GDP growth. Last Friday's retail sales data for September, along with substantial upward revisions to the prior two months, have set personal consumption on a respectable 2-2 1/4% path in Q3, while the widening of the trade deficit in August points to net exports becoming a bigger than previously assumed drag on growth.

The key though is that there appears to have been a faster pace of inventory accumulation last quarter, which represents a potentially worrisome development. While solid contribution of inventories to economic activity is an integral part of the dynamic in the early stage of an economic recovery (as businesses scramble to replenish previously depleted inventories in the midst of the downturn), an inventory bulge at this point is problematic. In all likelihood, any inventory build-up in Q3 was of the involuntary kind due to a pullback in final demands. The implication of that is that, unless final demand picks up in the current quarter, production cutbacks may act an impediment to a stronger pace of GDP growth in Q4.

Still, the degree of the negative role that the inventory situation may play in the current quarter will depend on the magnitude of both the inventory build-up in Q3 and also whether final demands will remain subdued in the current period.

All in all, growth continues to show no evidence of a near-term upswing and is headed for continuing sub par performance into the first quarter of next year, probably remaining in the 2 to 2 1/2% range.

Anthony Karydakis