Inventory Correction Masks Resilient Demand in U.S. GDP Report
Comment of the Day

October 29 2015

Commentary by David Fuller

Inventory Correction Masks Resilient Demand in U.S. GDP Report

Here is the opening of this assessment of US GDP by Bloomberg:

America’s economy pulled back in the third quarter as companies cleared out inventory. Beneath the surface, though, the government’s tally of gross domestic product showed buoyant consumer and business spending.

GDP, the sum of all goods and services produced in the U.S., rose at a 1.5 percent annualized rate after a 3.9 percent pace in the previous three months. Had it not been for the biggest inventory swing since 2011, the world’s largest economy would have grown 3 percent.

Household purchases, buoyed by job and income gains, will probably remain a mainstay of the economy even as weaker sales to overseas customers hold back exports and manufacturing. The quick re-balancing of stockpiles, which brings them more in line with demand heading into the holiday season, indicates factory production will soon stabilize, eliminating a source of weakness.

“The headline is not indicative of how solidly the U.S. is growing,” said Gennadiy Goldberg, U.S. rates strategist in New York with TD Securities, who correctly projected the third-quarter gain. “The domestic drivers in consumption are quite strong.”

Final sales to domestic purchasers, or GDP excluding the trade and inventories categories, advanced at a 2.9 percent annualized rate after a 3.7 percent pace in the second quarter.

David Fuller's view

It is no surprise that the Fed may wish to raise rates against this background in December.  Moreover, the Fed dropped its cautious comments from the 17th September Press Release about global economic and financial developments:

“Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term.”

That may sound sufficiently mild today but it probably contributed to some downward pressure on emerging markets at the time. 

The Fed last raised interest rates more than nine years ago in June 2006.  Consequently, there will inevitably be some nervousness surrounding the current probability of a rate hike in December. 

If the Fed does raise rates by 25 basis points before yearend 2015, fixed interest investments are likely to be the most affected.  For instance, widely followed US 10-Yr Treasury yields have risen in the last two days and are now at their highest level since September.  That does not look like much on the charts, although I maintain that ranging from 3Q 2011 onwards is a potential Type 3 (ranging time and size) base, as taught at The Chart Seminar. 

After a 35-year and counting bull market in terms of falling yields, many traditional bond investors may be unaware of the risks they face when yields really do start to rise.  It will be the old story of too many people in a crowed arena heading for the exit at the same time. 

See also: When Will the Fed Raise Rates?, by Kevin Granville for The New York Times)  

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