One Answer to the Curious Case of Residual Seasonality in US Real GDP

Source: CNBC on my TV!

Recently, Steve Liesman from CNBC here in the US pointed out that something was wrong with the US real GDP statistics.  He noted, and here I attach a picture of my TV at home showing his findings, that since 1985, Q1 real GDP growth for the US has been weaker than for other quarters.  Of course this should not be the case given that statistical seasonal adjustments are supposed to take account of any seasonality in the data and automatically adjust for this.  So we clearly have a problem with the US real GDP data, but I believe that Bureau of Economic Analysis (BEA) who produce the data, are going to fix this going back a few years, for their revisions in July.

In a way, this is extremely problematic though, and it stems from the way in which the media in the US reports it's GDP figures.  In Europe and elsewhere in the world, the standard way to report economic growth is by calculating growth as % year over year change in real GDP, which automatically adjusts for any "residual seasonality" in the statistics.  But in the US, GDP figures are reported as "quarter on quarter growth expressed as an annualized rate" - which therefore does rely much more on an accurate adjustment for seasonality in the GDP figures.

Now you are probably thinking - "well who cares?"  Well unfortunately these figures are very important, not only in terms of setting the tone of the US stockmarket, but also in terms of policy measures, such as the adjustments of interest rates by the Fed!  Many of the market commentators saw the revised GDP figures last week with the "Second estimate" of Q1 GDP showing a contraction of 0.7% in (annualized growth in) real GDP as a blow to the recovery and tried to blame this on everything from the port strike on the West coast to the frigid weather in the first quarter. Even commentators said that the economy is too weak for the Fed to move in June to increase interest rates.

But I thought that for this week's blog I would take the real GDP growth figures and re-express them in terms of Year over Year growth. So that's exactly what I have done in the figure below.  This, I would argue is a much better way to judge our economic growth, and when you look at it this way, it is really not too shabby in my view.

Source: BEA.gov; Data calcs: Blog author

Now viewed in this light, a 0.7% contraction, turns into a 2.7% growth rate, which was an acceleration from Q4 of 2014.  Now if you look at the figure above, you'll see that although although consumer spending (C) is drifting in an upwards direction, it is 7.4% increase in private investment spending (I) that appears to have caused the uptick in the GDP % yoy growth data for Q1. Note also that since turning negative in 2010, government spending (G) has also moved into positive territory.

Now what of the international sector.  Well here, if you look at the data, the news isn't good whichever way you report it.  If you use the % YOY method that I use here, you will find that exports fell 22.7% YOY, and imports increased 6.5% YOY.  And in the investment category, if you take out the accumulation of inventories from the figures, investment only increased by 5.2%, which although still impressive, does suggest that business investment still needs to be boosted by consumer spending, which is still quite hesitant.

But from my own perspective, these figures bolster my view that although the Fed probably won't do a rate rise in June or July, they should.  The economy is growing as strongly as it has been at pretty much any time since 2010 when you measure economic growth in the best way possible, by using the %YOY method!  Also, while I know that the strength of the US dollar matters (more on that for another post), the main measure of robust growth in an economy is domestic spending or "absorption".  If the US Treasury and Fed have an exchange rate policy of benign neglect for the US dollar, then the movement of the US dollar should not dictate or effect the direction or timing of monetary policy.

March Madness, then April Fools, and they didn't go away in May!!

So spring is now over in South Texas as temperatures head back into the 90s and 100s after a colder than usual winter.  But of course the transition from winter to summer is punctuated with March Madness and then the foolishness of April, before the academics and market participants traditionally "go away in May".  This March and April have been particularly crazy, what with more cold weather in March and April, and some really eye popping things going on in the real economy as well as the financial markets.  With bond yields heading lower for no apparent sane reason, I was thinking that this must be an extended bout of March madness and April fools, and that things will correct themselves in May, but alas things have now started to get completely out of hand.

US PPI food (mom): Source BLS

US PPI (yoy): Source BLS

Any economist looking at the PPI numbers released last week for April (see http://www.bls.gov/ppi/ for a breakdown) would interpret this as an uptick in inflation.  The chart taken directly from the BLS website below for year over year producer price inflation shows this.  But what is more surprising is that the food component of the index appears to be definitely showing a spike upwards.  The next chart shows this for the food component of PPI on a month over month basis (2.1%), which comes in at a 5.2% year over year rate.  Now I don't know about you, but I tend to have to eat food, and so this will likely feed through (sorry about the pun) into the CPI pretty quickly, and will affect a whole bunch of things, including supermarket prices, eating out, cruise prices, and anything where food is involved.  

Source: US Treasury website

Now given this, I would have thought that bond yields would have "popped" as a signal (albeit not completely confirmed) that the PPI increases would be a pre-cursor to higher inflation and therefore a quicker move to monetary policy tightening.  But no, bond yields didn't increase, or stay constant, they moved sharply lower. The figure below shows how at the longer end bond yields definitely moved in a downwards direction, while short rates still appear to be anchored at almost zero by Fed monetary policy. This is fast becoming unsustainable as we shift gears to a more growth-inflationary environment. Anyone who has booked an airline ticket, bought a vehicle or been to a supermarket lately knows that prices are definitely moving up as the economy firms.

Now there are some economists who seem to think that the negative Q1 US GDP figures (-1% quarter over quarter at an annual rate) point to an economy teetering on recession or at least in a slowdown or holding pattern.  I think they are dead wrong.  Why?  Well first the way in which the US measures it's economic growth is strange to say the least. I know that -1% shrinkage in the US economy sounds bad, but this is simply due to the compounding of what was a bad weather related quarter.  A more sensible way (which most other countries use) to measure economic growth is to use the year over year change in real GDP.  If we do this, we find that real GDP increased by 2.05 percent - which is not exactly a roaring economy, but it is not bad at all.  Second, with strange weather patterns, it becomes really hard to work out the seasonal adjustments that should be done on the data.  If you use a quarter on quarter measure to assess economic growth, then you have to do seasonal adjustment and any errors are then compounded when you multiply up the figure to an annualized rate.  Using a year over year rate obviates all those problems as you don't have to worry about seasonal adjustment as you are comparing figures from the same season of the year.  

So to the left I have plotted the log change in real US GDP ( - this is just the same as doing a % yoy change calculation).  It is clear that even with the really bad weather that the US economy experienced in the 1st quarter, that the economy is humming along, and in year over year terms, the rate is roughly in line with what we've been seeing for the past couple of years.  

But of course, this means that without the bad weather, the year over year rate might have been significantly higher, perhaps a full 0.5% higher, in which case the economy in fact would have been expanding at it's fastest rate since the last recession ended.  

Now if my view is right, the Fed must be starting to get worried that what it is (not) doing is being misinterpreted as a signal to the markets that it will not move if inflation really does start to move higher as it looks to be doing right now.  When I hear Janet Yellen stating that interest rates will remain low for the next 5 to 8 years, I think some in the market interpret this as easy money for the next 5 years at least, but what they don't seem to understand is that the economy is cyclical. 5 years have now passed since the end of the last recession, so that as we move forward over the next 3 years another downturn becomes more and more likely. In other words, given the history of business cycles we are likely already more than half way through the current growth phase of the business cycle. The Fed therefore will likely have to move fast in order to "normalize" monetary policy so it can be prepared for the next economic downturn.  And in that last sentence you notice that I am not saying "if" it comes - no, it will come alright, and in my next econoblog I will show how some of the research that I am doing looks at these cycles in growth highlights the continuing fluctuations in growth patterns and how they can be interpreted as following a cyclical pattern.