Why the Fed forecast revised the gross domestic product estimate
Gross domestic product estimate
The U.S. Bureau of Economic Analysis (or BEA) will release the second estimate for first quarter gross domestic product (or GDP) on Wednesday, June 25. The GDP is a nationwide measure of economic activity impacting all sectors. As a result, economists and analysts watch this report very closely. An estimate that is higher or lower than market expectations can cause significant movements in both stock (VOO) and bond (AGG) markets.
The BEA releases three estimates for GDP growth. The first report is usually released a month after the quarter has ended and is known as the advance estimate. The BEA releases the second and third estimates, in the second and third months after the end of the quarter which are known as the second and final estimates, respectively. The release on June 25, is the third and final estimate for first quarter GDP.
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Key takeaways from the second GDP estimate
The GDP actually contracted by 1% in the 1Q14, according to the second estimate released by the BEA on May 29. This was down sharply from the advance estimate released earlier, which had come in at 0.1%. More importantly, markets had to grapple with the idea of declining economic growth in the first quarter after three strong quarters of growth from 2Q13–4Q13. Also, a lot of economic releases in March and April were pointing to a recovery. These included the critical areas of job creation and manufacturing—both had shown healthy figures for March and April. Due to these factors, market participants started questioning the strength of the recovery.
The weather figured prominently in explaining the sub-par figures in the first quarter. Regarding the downward revision, the BEA release stated that “With this second estimate for the first quarter, the decline in private inventory investment was larger than previously estimated. The decrease in real GDP in the first quarter primarily reflected negative contributions from private inventory investment, exports, nonresidential fixed investment, state and local government spending, and residential fixed investment that were partly offset by a positive contribution from personal consumption expenditures. Imports, which are a subtraction in the calculation of GDP, increased.”
The U.S. Federal Reserve has already revised its growth estimate for 2014 GDP, when it released its economic projections at the end of the June Federal Open Market Committee (FOMC). The Fed’s real GDP growth estimate for 2014 was revised to 2.1%–2.3% from 2.8%–3% at the end of the March FOMC. This would imply that recent positive economic data in the second quarter of the year, won’t be enough to make up for the sub-par first quarter and maintain the growth momentum seen in the last two quarters of 2013.
While the manufacturing sector (VIS) continues to move forward, consumer spending (which accounts for over two-thirds of the GDP) continues to hinder the GDP. However, with the labor market getting back on its feet, cyclical stocks should do well in the months ahead. Technology companies like Microsoft and Cisco, should also do well because corporate spending on technology usually increases when the economy advances. Both companies are part of the Technology Select Sector SPDR ETF (XLK) and the Vanguard Information Technology ETF (VGT).
In the following section, we’ll analyze the outlook for consumption and the Fed’s favored inflation measure—the change in Personal Consumption Expenditure.