Comments on the 1Q GDP Growth Revision Downward

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We had anticipated that the ho-hum initial GDP growth figure for the first quarter of 1.3% might be revised downward. Thursday, the Commerce Department changed its GDP estimate to 0.6% and altered many of the components. In particular, it increased its estimate of consumer spending growth from 3.8 to 4.4%.

Not only was the 4Q GDP also revised downward, raising suspicions in some quarters, but this same pattern took place in the last slowdown (the 2Q 2002 revision downwards was substantial).

Mike Shedlock at Minyanville pounced:

If one believes as I do, that the first 2% of GDP is hedonics, imputations and other fictional activity (e.g. the estimated value of things like free checking accounts – yes I am serious – added into the GDP numbers), then we are already in a recession starting now.

What is most interesting is the notion that this is some sort of optimistic report. It is not. Rather than looking at inventories that have to be replenished, the correct way to look at things is that GDP was up a mere 0.6% in spite of very robust consumer spending. If +0.6% GDP is all the US can muster with strong consumer spending, it should be obvious what will happen when consumers toss in the towel.

Nouriel Roubini also weighted in:

As expected US Q1 GDP growth was revised down to 0.6% from its initial estimate of 1.3%; 0.6% was even worse than the consensus forecast of 0.8% and this blogger’s forecast last month of 0.7%. This means that in Q1 of this year the US was already in a “growth recession”….

Of course the consensus today is that Q1 was the bottom of the US growth slowdown and that GDP growth will recover to a level above 2.0-2.5% in Q2 and for the rest of the year. I.e., the consensus is that we are in a temporary soft patch. While some supply side data suggest a stabilization of some sectors of the economy (manufacturing, services, etc.) the key concerns now are the deepening housing recession and whether the US consumer is on the rope. Let us discuss both of them.

As far as housing is concerned, the housing recession and the credit crunch in the mortgage market are clearly worsening. This writer was the featured speaker the other night at an event organized by one of the top 10 global financial institutions; after I gave my bearish outlook for the US economy and the housing market (in a debate with the chief economist of this firm), the four senior analysts of this bank for the housing sector, the mortgage lender sector and the MBS sector gave their outlook (it is all in public reports available for clients/investors of this firm).

In brief, their view is that: the housing market is still weakening and – based on their May survey of traffic – housing sales traffic is close to dead; it would take developers to shut down all new construction for almost a year to get rid of the excess supply of unsold homes; thus, downward home price action may continue for the next two years; the credit crunch in the mortgage market is only at its early stages and the distress and crunch is spreading from sub-prime to Alt-A and near prime mortgages; the major mortgage lenders have not yet started to get a reality check on how bad their assets are and properly mark them to market; the ABX index (the BBB- tranche) collapsed from near parity down to 60 in the last few months and has now recovered to close a still low 67; but, given how lousy were mortgage originations in 2005 and 2006, deliquencies in subprime will further increase in the next few months and further downward pressure in the ABX indexes may be expected.

This writer has been a serious bear on housing for a long time: but after listening to these most sophisticated analysts of housing, mortgage lending and the MBS markets from a top global financial firm my concerns seemed almost not bearish enough. The main message from these analysts and the data is that the housing recession, the subprime carnage and the broader mortgage mess are getting worse, not better; and things will get worse well into 2008. There is no end in sight to the housing recession and we are only in the first innings of the mortgage credit crunch.


Nevertheless, the Financial Times anticipates that the Fed will take a “no worries” posture:

The anaemic performance was worse than economists expected but is likely to be viewed by the Federal Reserve as a prelude to a broad-based recovery.

The Fed said in minutes published on Wednesday that it expected a moderate pickup in growth in coming quarters.

If that turns out to be correct (likely), one has to wonder about the Fed’s posture. Can they truly believe what they are saying, despite the preponderance of worrisome evidence? Or is this a case, despite pledges of greater transparency, of keeping its concerns private to avoid making a deteriorating situation worse?

Personally, I suspect something more complicated is at work. The Fed has to take a positive, or at least balanced sounding tone, regardless of the underlying situation (Americans, particularly ones in the financial services industry, have little tolerance for unvarnished truth). Certain studies have found that repetition shapes opinion. I suspect the Fed is starting to believe its own PR.

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