Bank of the West US Outlook Report for July 29, 2016

Weak Growth in 1H 2016- What’s Next?

The advance estimate of Q2 GDP revealed a modest improvement in U.S. economic growth to a 1.2 annualized rate up from a revised sluggish 0.8 percent growth pace in the first quarter. Real GDP growth averaged just 1.0 in the first half of 2016. The initial estimate of Q2 GDP came in well below consensus expectations for a 2.5% increase. The Bureau of Economic Analysis published GDP revisions back to Q1 2013 with this release.

An outsized snap-back in real consumer spending in Q2 was nearly the lone driver of GDP growth last quarter.  The second quarters 4.2 percent annualized growth in real consumer spending was one of the biggest quarterly increases in U.S. consumer spending in this expansion.  You have to go all the way back to the fourth quarter of 2014 to find real consumer spending growth north of 4.0 percent.

But beyond the consumer there wasn’t a lot to cheer about. Business fixed investment slipped for the third consecutive quarter in a row with declines in structures and equipment investment. In fact, private investment plunged at a 9.7 percent annualized pace in the second quarter as residential investment also dropped at a 6.1% annualized rate and business inventories fell.  The Private investment drop alone subtracted 1.7 percentage points from Q2 GDP growth.

Business inventories fell outright in Q2, dropping by $8.1B, down from a $40.7 billion increase in Q1.  The swing in inventories subtracted another 1.16 percentage points from Q2 GDP growth.  Shrinking inventory growth has been subtracting from U.S. GDP for five consecutive quarters now.  The Q2 drop was the first since the third quarter of 2011.  We believe inventories have been pared back enough at this point that it will no longer be a drag on GDP growth going forward.

Surprisingly, the U.S. trade deficit narrowed in the second quarter by about $10 billion as exports grew 1.4% and imports slipped -0.4%. Net exports ended up adding 0.23 percentage points to GDP growth in Q2. Monthly trade reports had pointed to a sharp deterioration in the trade deficit in Q2.

What’s instore for real GDP in the quarters ahead?  We expect a rebound in U.S. real GDP growth in the second half of 2016 to around 2.4% annualized. Real consumer spending should slow to a more sustainable pace of around 2.7 percent, but offsetting, we expect a return to modest growth for business investment and residential investment.  A resumption of U.S. business inventory growth should also help add to GDP in the quarters ahead.

However, the worse than anticipated drop in durable goods orders again in June, down 4.0% on the month after a 2.8% revised decline in May, suggests the improvement in business investment and manufacturing is going to be a gradual process at best.

To find out more, check out this week’s US Outlook Report.

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