Today’s report that spring quarter GDP growth was revised down from 2.4% to 1.6%, well below the 3.7% pace during the winter, was expected and is already having a depressing impact on business and consumer spending confidence. This assures subpar growth for at least several more quarters and a delayed and slow recovery in construction spending. But it does not assure a double dip recession. That is still unlikely. Final sales to domestic purchasers jumped 4.3% in the second quarter, the strongest gain in several years. This is GDP excluding the impact of trade and inventory change. Both weakened sharply in the spring after several strong quarters. The strong spring surge in spending makes a quick return to recession very unlikely. No recession has ever quickly a quarter with growth in business investment (+25.0%) and consumer durables spending (+3.6%).
The 2nd Q had a bizarre mix of spending growth. The booming investment sector contributed 2.8 percentage points to GDP growth, double the contribution from the much larger consumer sector. Construction contributed 0.6% to GDP growth. This was almost entirely from housing although the nonresidential sector (buildings and civil) made a marginal contribution to growth after seven quarters of subtracting from GDP growth. Government contributed 0.9 percentage points to GDP growth. This is 50% more than typical due to aggressive pump priming. The trade sector subtracted 3.3% from GDP growth due to a 32.4% surge in imports. The quarterly trade impact on growth is very volatile so this large subtraction is in the normal range but it is unlikely to be repeated during the summer.
The message in today’s GDP report is that consumer spending has significantly weakened and will drag down the rest of the economy, beginning with business investment, within a few quarters if consumers tighten their budgets any further. Already, orders for machinery fell 15% in July and new home sales fell to a record low level. The base case outlook is still that consumer spending will grow enough that we muddle through the rest of the year with GDP continuing to rise. This requires a pickup in consumer confidence.
Although spending growth began to weaken in June and will weaken further through the summer, 3rd Q GDP growth will be reported to be higher than the 1.6% rate in the 2nd Q. This is because any slowdown in business fixed investment and housing will be partially offset by a rise in unwanted inventory and the import surge will subside in a period of sluggish sales. The headlines will say that economic growth has improved but the spending report, final sales to domestic purchasers, will show weaker economic growth during the third quarter.