Don't Take First Quarter GDP Revisions at Face Value

First quarter U.S. GDP slipping to minus 0.7% as reported last week may look bad, but economists predicted worse: minus 0.9%. The “advance estimate” of any given quarter’s GDP growth is released about a month after quarter-end, and is followed by additional estimates one month and two months later (last week’s report was the second estimate of first quarter GDP growth). Our conclusion is the same as when the reading was initially released: weak first quarter GDP growth is likely transitory. This time, the revision downward was driven by import growth likely caused by enhanced purchasing power via a stronger U.S. dollar. Goldman Sachs noted that the drag on GDP growth from higher imports was the most severe in thirty years. Even though the U.S. economy shrank in the first quarter, the Atlanta Fed claims the chances we slipped into recession are low: “The latest data are more consistent with a temporarily weak quarter than evidence of more serious problems for the economy.” If GDP growth is consistently weak in the first quarter (as we wrote about here) despite “seasonal adjustment,” one might conclude something is wrong with the measure itself. Two weeks ago, the Bureau of Economic Analysis (the division responsible for GDP estimating) announced a “multi-pronged” plan to remove “residual seasonality” in its calculations beginning with the July 30, 2015 GDP growth estimate and applied retroactively all the way back to 2012. The San Francisco Fed speculated that with better seasonal adjustment techniques first quarter GDP growth might have been as high as 1.8%. So the trend of fishy first quarter GDP estimates may be coming to an end. Looking forward, estimates for second quarter GDP growth are more positive. The Atlanta Fed’s GDPNow forecast, which, compared to Wall Street, accurately estimated first quarter GDP growth, stands at 0.8%, far below Goldman Sachs’ estimate of 2.4%. Fed Chair Janet Yellen only offers that the second half of 2015 will likely be better than the first. Our portfolio positioning reflects the view that even if GDP growth comes in strong (as it did at the end of 2014 when rates fell), economic growth alone cannot move interest rates higher. Inflation has been and, in our view, continues to be driving the bond market.

Sources: GS, BEA, Atlanta Fed, SF Fed, SNWAM Research