The final read of Q1 GDP was revised lower to -2.9% from a prior -1.0%. The Q1 contraction was not all weather. Much of it was a retrenchment from a robust Q3 and early Q4 2013. Although this is lagging data, it is important because we cannot know where we are (or where we are going) if we don’t know where we have been. The result is that we need Q2 GDP of 3.0% just to get the economy basically even with economic conditions at the end of 2013. Think of it this way. If someone is standing at sea level and jumps three feet in the air, one reaches three feet above sea level. However, if one is standing three feet below sea level in Death Valley and jumps three feet in the air, then one merely rises to sea level. This is where we think the economy is right now, back to sea level.
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What caused the downward revision. Healthcare spending was revised sharply lower as the final data indicated that consumers spent less on healthcare than originally estimated. This is being viewed as good news as it indicates that increased healthcare spending might not be constraining household budgets as much as expected. We view this phenomenon as troubling as it indicates that consumer budgets were constrained even without a sharp rise in healthcare spending. Yes, household budgets crimped by a cold winter (energy spending, snow removal and, in some cases, fewer hours worked), but a Q1 GDP print of -2.9% is terrible. This is true even when a harsh winter (which did not affect much of the Country) is considered. In fact, this was the biggest quarterly contraction of growth outside of a recession in U.S. history. It was also the third biggest contraction since 1980. If the Q1 contraction of 2.9% was mostly due to the weather, it still underscores the fragility of the U.S. economy.
U.S. GDP since 1980 (source: Bloomberg):
Q3 should be another 3.00%+ quarter as businesses gear up for the holiday shopping season, but Q4 could fall back into the 2.00% to 2.50% area. Considering that growth in the first half of 2014 could be essentially flat, 2014 GDP growth could average between 2.00% and 2.50%. The way we see it, 2014 might not look much better than 2013 and 2015 might end up only modestly better than 2014. (5)
More timely data indicates that the economy continues to grow moderately. May Durable Goods fell 1.0%. Ex Transportation (which can be volatile) May Durable Goods came in -0.1%. One bright spot is that Capital Goods Orders Non-Defense Ex-Aircraft rose 0.7%. This can be good news if businesses are adding equipment and workers to operate it. It can be bad news if businesses are adding equipment to take the place of workers. Only time and data will tell. (5)
Our forecast for the first Fed Funds Rate hike remains June 2015. However, we are becoming increasingly doubtful that the 10-year note yield will make in back to 3.0% by year end. A year-end yield of between 2.60% and 2.85% seems more likely.
At the time of this writing the price of the benchmark 10-year Treasury note is up 12/32s to yield 2.535%.
By Thomas Byrne – Director of Fixed Income – Investment Consultant
Thomas Byrne brings 26 years of financial services experience to Wealth Strategies & Management LLC. He spent the last 23 years as Director of Taxable Fixed Income for Citigroup, Inc. and predecessor firms in New York, NY. During the course of his long fixed income career, Mr. Byrne was responsible for trading preferred stock, corporate bonds, mortgage backed securities, government debt, international debt and convertible bonds. Mr. Byrne was also responsible for marketing, sales, strategy and market commentary within the taxable fixed income markets.
- November 2012 – Present, Wealth Strategies & Management LLC, Stroudsburg PA
- December 2011 – November 2012 – Bond Squad, Kunkletown, PA
- April 1988 – December 2011, Citigroup and predecessor firms, New York, NY
- June 1986 – March 1988 – E.F. Hutton, New York, NY
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