Must know: Impact of this week’s economic releases on debt markets

Part 4
Must know: Impact of this week’s economic releases on debt markets (Part 4 of 8)

Must know: The impact of Friday’s GDP release on the Fed stance

As per a preliminary data release by the Bureau of Economic Analysis on January 30, real gross domestic product (or GDP) increased 1.9% in 2013 year-on-year, in comparison to an increase of 2.8% in 2012. The Bureau will release the second estimate for 2013 and fourth quarter GDP on Friday, February 28. It will be based on more complete data.

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What is gross domestic product (or GDP)?

The GDP of a country is the total market value of all final goods and services produced within a country within a specified time frame, for example, a quarter or a year. Encompassing all sectors of the economy, it’s one of the best means to measure the economic size or health of a country. Very broadly,

GDP = Total Consumption + Total Investment + Government Expenditure + (Exports – Imports).

What did the preliminary estimate for 2013 GDP indicate?

Real GDP increased 1.9% in 2013 year-on-year, in comparison to an increase of 2.8% in 2012. This increase was primarily due to increase in personal consumption expenditures, exports, residential and non-residential fixed investment, and private inventory investment that were partly offset by a negative contribution from the federal government spending and an increase in imports.

The pace of growth in real GDP slowed in 2013 primarily due a deceleration in non-residential fixed investment, a larger decrease in federal government spending, and decelerations in personal consumption expenditures and in exports that were partly offset by a deceleration in imports and a smaller decrease in state and local government spending.

How does the GDP impact debt markets?

An increase in real GDP implies that the economy is expanding. Other factors remaining constant, when the economy is expanding, the demand for money is higher as investors are eager to commence new ventures due to positive underlying business sentiment. The increase in demand for funding tends to raise interest rates, lowering bond prices, and ultimately, implies costlier debt. A decrease in GDP would imply the opposite.

Further, other factors remaining constant, an increase in real GDP would imply that the Fed may discontinue its monthly bond purchases ($65 billion per month currently), that is, continue with the taper. This would mean tighter liquidity, higher interest rates, and lower bond prices. A decline in real GDP would imply the opposite.

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