US Q2 GDP – Robust strength offsets Q1 contraction
Last week’s data-packed schedule delivered important economic releases, thus shedding more light on the evolving state of the US economy. After the dismal Q1 GDP print (latest estimate of -2.1% q-o-q annualised), the narrative of economic stagnation started to take hold, especially with tracking estimates of Q2 GDP consistent with a less than robust bounce. However, the Q2 release came in much stronger than expected at 4% q-o-q annualised. The upswing was led by consumer spending and business investment with inventories also contributing. Indeed, stripping out the volatile inventories component, final sales to domestic purchasers came in at a very robust 2.8%, which is the strongest print since Q3 2011.
All in all, we think that the latest GDP print has helped to allay the sustained economic stagnation fears and it confirms that the economy rebounded from the sharp contraction in Q1 with impressive speed. Moreover, high frequency indicators such as the ISM business surveys show that the economy started Q3 on a solid footing as the manufacturing indicator notched a multi-year high level of 57.1 in July.
Payrolls vs. average earnings
The improvement experienced in US labour market dynamics is beyond doubt. The unemployment rate has fallen by 0.5ppt since the December reading and non-farm payrolls are averaging approximately 230K per month so far in 2014 compared to around 190K in 2013, which is a minor improvement over the 186K per month on average recorded in 2012.
However, as we have discussed, in recent months the policy narrative has shifted from focusing on short-term labour market dynamics to structural underpinnings of the US economy. This has been depicted by the interplay between the output gap and wage/inflation dynamics.
Because the output gap and associated slack are unobserved variables, it appears that the key clearing price in the economy (i.e. wages) is being used to calibrate the current monetary policy response. The idea underlying this thinking is quite simple. As slack in the economy is difficult to observe directly, the Phillipps curve construct (which conceptually connects magnitude of slack in the economy with rate of inflation/wage growth) helps to detect if the output gap (difference between potential and actual output) has closed. This indirect assessment is undertaken by analyzing the behavior of wage growth ( directly observable), which would start to accelerate as actual output draws closer to or beyond the economy’s potential.
