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US Bond Market Week in Review: Weak 2Q GDP Supports The Fed’s Holding Pattern on Rates

     Last week, the Fed maintained their current rate policy, despite the objection of three governors.  In last week’s piece, I noted that the long-leading, leading and coincident indicators all supported this conclusion.  This week, the BEA released the final revision to 2Q GDP, which showed an economy that is growing “moderately.”  This also supports the Fed’s decision. 

     Let’s start with the consumer, who is responsible for 70% of U.S. growth:

The chart above breaks down consumer spending into durable, non-durable and service categories.  All three are expanding at strong rates.  Since the 1Q14, non-durable spending (red) has increased between 2.1% and 3% YOY while service spending (green) grew between 1.7% and 3.1% YOY.  But durable goods expenditures really stand out; their weakest pace of YOY expansion was in 1Q14 when they rose 3.9%; their strongest pace was in 4Q14, when they expanded at a torrid 8.6% rate.  More recently, they’re fallen to a more sustainable 4%-5% YOY rate.  But, this chart shows the U.S. consumer is spending at a consistent and strong pace.

     Next, we have investment:

Residential investment (purple) provides the best news, closely followed by intellectual property spending (green) spending.  But commercial real estate (blue) has been contracting on a YOY basis for 6 quarters and equipment spending (red) has been negative for 2.  Some of this is oil and gas related; when oil prices dropped, the massive infrastructure build-out in the oil patch slowed to a halt.  But it’s doubtful this is the only explanation; there is most likely an ancillary slowdown occurring. 

     Let’s turn to trade:

There are 2 reasons for the slowdown in exports: the strong dollar and weak global demand.  The drop in imports, however, is a bit more concerning.  When US demand increases, imports rise to supply various goods.  But this chart shows weaker imports, implying weaker domestic demand.

     Looking forward to the remaining meetings, this news implies we might not see a rate hike by year-end.  The 2Q data shows weakness in 2 areas: business investment and exports.  That places all the weight of growth on consumer’s shoulders.  And while income is still growing, spending on “things” is a bit weaker.  The NY Fed is predicting 2.2% 3Q growth while the Atlanta Fed’s is forecasting 2.4%.  But Fed governors recently lowered their median GDP 2016 predictions to under 2%.  Add to that recent ISM manufacturing and service sector weakness, declining corporate earnings and weaker durable goods orders, and you have a recipe for weak growth.

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