Fourth-Quarter Real GDP Growth Disappoints, Investors Send the Ten-Year Treasury Yield Below 1.70%

The “advance” estimate for real annualized fourth-quarter GDP growth came in under expectations at 2.6%. This data release offers the first calculation of 2014’s full-year real GDP growth of 2.4%, compared to 2013’s 2.2%. In response, investors flocked to the safety of U.S. Treasurys. The ten-year Treasury yield dipped below 1.70%, a level not reached since May 2013, and continues inching closer to the all-time low of 1.39% reached in July 2012. The drivers of the lower-than-expected GDP report include a sharp decline in government spending, a deceleration in exports and stagnating real wage growth. Notably, the national defense segment of federal spending decreased 12.5% in the fourth quarter versus an increase of 16% in the third quarter. President Obama’s recent budget proposal does include a 7% increase in federal defense spending and targets unwinding the “harmful sequestration cuts,” both of which stand to help reverse the decline in government spending, but his proposal is likely to meet staunch resistance from the Republican-controlled Congress. Exports decelerated to 2.8% growth compared to 4.5% in the third quarter, and are further strained due to the multitude of global central bank policies aimed at weakening foreign currencies against the dollar. Bloomberg’s Dollar Spot Index shows the U.S. dollar (in terms of relative purchasing power versus a basket of ten global currencies) at its strongest level since data was first collected in 2005. The Employment Cost Index reported total compensation (including wages and benefits) increasing 2.2% in 2014. When adjusted for inflation, however, wages have barely increased at all. Considered together, these developments do not paint a rosy picture for real growth prospects in 2015. A singular bright spot might be consumer optimism, which has increased to the highest levels since before the Great Recession. U.S. real growth was one of the few catalysts for higher interest rates. Without a reversal of some of the negative trends mentioned above, we see a low probability of rates moving up markedly and perhaps an increased likelihood they move lower even if the Federal Reserve decides to increase their policy target this year.
 
Sources: BEA, White House, Bloomberg