There are numerous inconsistencies with the recently released strong Q1 GDP figures, notes Landon Whaley.
This week’s “Headline Risk” focuses on the risk of exclusively paying attention to the headline number of a data series. Based on the U.S. government’s initial release of Q1 GDP last week, U.S. growth accelerated 24 basis points from Q4’s annual pace of 2.97%, up to 3.21%. In addition to “Trump-ing” expectations, this report confirms the U.S. expansion is back on.
There is no question that the annual growth rate (the highest since Q2 2015) is impressive, but if we look underneath the hood, three things jump out that give us cause to pause.
First, inventories and net exports accounted for over half of the 3.2% growth rate, which is the largest impact on GDP growth these two inputs have had since Q1 2014. These two sub-components of the GDP calculation are notoriously volatile and often highly revised in subsequent GDP revisions. In April we discussed the trick that soybean exports played on unsuspecting investors when the Q4 GDP report was released. The initial report showed an 8-basis-point acceleration from Q3’s GDP growth rate but the second report showed an 18-basis-point decline. Both the initial acceleration and the subsequent -26-basis-point revision were entirely attributable to soybean exports.
Second, one of the best indicators to gauge true domestic demand is the real final sales component of GDP. The Q1 growth rate of real final sales slowed 0.6% from its Q4 final sales growth. This final sales slowdown is supportive of the growth slowing data we saw throughout January and February from the ISM as well as “hard” data sets like industrial production, which slowed consecutively in all three months.
Third, and this is the one that is the real head scratcher, the GDP deflator (inflation rate) the government used to calculate Q1 GDP was +0.64%. I honestly have no idea where they pulled this inflation rate, but I’m guessing it’s the same place that allows us to sit comfortably.
From an economic data perspective, consumer inflation is running 1.9%, core inflation is 2.0%, and producer prices are growing at a 2.2% pace. From a real-time market perspective, crude oil is up 36% for the year, and a basket of broad-based commodities (including the ags) are up 11.0% year-to-date. Inflationary impulses are all around us and are beginning to run hotter, yet the government is trying to tell us there is no inflation at all. What the fudge?
Maybe you’re wondering, how big of a deal could this be? Here’s your answer: If GDP were deflated using the government's CPI calculation, Q1 GDP growth would be halved to a growth rate of just 1.6%. Bam!
Now I’m not sitting here wearing a tin foil hat implying the United States is taking a page out of China’s playbook and simply “goal seeking” the economic results they want to report. However, this ridiculous understating of inflation is apt to be a gateway to more economic data manipulation in the future.
The headline risk bottom line is its critical to evaluate the inputs that drive an overall calculation like GDP growth to understand what’s truly going on. Regardless of the veracity of the report, Q1 is in the rearview mirror and this game is played in front of us. GDP growth in the first three months of the year doesn’t change our view that U.S. growth will slow from here (in fact, it makes even more likely) and inflation will ramp higher.
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