Friday, July 29, 2005

If this is a bad GDP report, what does a good one look like? 

The markets are soft today after the GDP report came in with 3.4% growth. But buried in the report itself is good news.

The real change in private inventories subtracted 2.32 percentage points from the second-quarter change in real GDP after adding 0.29 percentage point to the first-quarter change. Private businesses reduced inventories $6.4 billion in the second quarter, following increases of $58.2 billion in the first quarter and $50.1 billion in the fourth.

Real final sales of domestic product -- GDP less change in private inventories -- increased 5.8 percent in the second quarter, compared with an increase of 3.5 percent in the first.

As my dad would say, "in English, please?" It means that in real terms, businesses who had stockpiled lots of inventory over the previous six months sold it all off in the previous quarter. It seems unlikely that they would continue to disgorge inventories (already at the 1.3 benchmark as a ratio to sales), so production should pick up again in the next quarter. A 5.8% growth of final sales is the best since the second quarter of 2003.

This report also showed a turnaround in net exports, with imports decreasing 2% in the quarter. This and the Chinese repeg of the yuan might mark the end of that drain on GDP growth going forward.

The bond market has reacted towards the notion that the Fed would continue to increase interest rates by increasing yields at the long end of the yield curve. The market is already prepared for a 4% Fed funds rate by year-end; it's beginning to put non-zero probabilities on a 4.25% rate.