Red Flags Flashing: Negative GDP Math Exposed

Resilient-Economy Thesis Holds Despite Latest Economic Indicators

The latest economic indicators have painted a grim picture, casting doubts on our resilient-economy thesis. However, we remain committed to this view for now. To understand the reasoning behind this stance, let’s delve into the data and analyses presented in recent reports.

GDPNow Tracking Model Reveals Negative Growth Rate in Q1

The Atlanta Fed’s GDPNow tracking model has been a crucial tool in assessing the economy’s growth prospects. Recently, it lowered the estimated growth rate of Q1’s real GDP from 2.5% (q/q, saar) to -1.5% on Friday and then further to -2.8% on Monday. The downward revision was attributed to a significant increase in imports during January and a drop in consumer spending.

Upon closer inspection, the January data revealed a substantial hike in imports, totaling 29.7% y/y, which surpassed even the most optimistic predictions. This spike in import growth was largely driven by firms front-running Trump 2.0 tariffs, which had a profound impact on the GDPNow tracking model’s estimate of real GDP.

However, we must consider the fact that the correlation between the M-PMI and quarterly growth rate in real GDP of goods isn’t particularly high, especially when the economy is expanding rapidly. While the M-PMI has been mostly below 50.0 since late 2022, the quarterly growth rates have remained relatively stable.

Citigroup Economic Surprise Index Turns Negative

The Citigroup Economic Surprise Index (CESI) has experienced a recent turn for the worse, plummeting to -16.5 on Friday. This sudden downturn serves as a stark reminder of the growing concerns regarding the economy’s trajectory.

Monday’s M-PMI report for February was weaker than anticipated, with a reading of 50.3, down from 50.9 in January. Notably, both the new orders index (48.6) and employment index (47.6) fell below 50.0 last month, further highlighting the challenges facing manufacturers.

Regional Business Surveys: Overemphasis on M-PMI and NM-PI

The Atlanta Fed’s recent downgrades suggest that they may be placing undue emphasis on regional business surveys conducted by five of the 12 Federal Reserve district banks. These regional surveys often misrepresent national trends, leading to an overly optimistic assessment of the economy.

We acknowledge this overemphasis might be partly driven by investors’ desire for clarity and stability in uncertain times. In our analysis, however, we will continue to track regional business surveys as a secondary metric, keeping a close eye on key indicators such as prices-paid and prices-received indexes.

Revised Construction Report and Residential Components

Following the release of Monday’s construction report for January, the GDPNow model revised downwards sharply, reducing the residential construction component of Q1 real GDP from 1.4% to -4.9% y/y and lowering the nonresidential structures component from -2.0 to -2.5% y/y.

While actual m/m changes in these categories were minor (-0.4% and 0.1%), their revised projections suggest a weakening in construction activity, contributing significantly to the overall downward revision in Q1 real GDP growth estimates.

Personal Income Jumps in January, Despite Consumers Cautiously Spending

Personal income witnessed a notable increase of 0.9% m/m during January, with total wages and salaries rising by just 0.4% m/m. The surge in personal income was primarily driven by government social benefits (1.8%) and nonlabor income (1.2%).

In an unexpected twist, despite this significant jump in revenue, consumer spending actually declined by 0.2% m/m. Consequently, the personal saving rate expanded from 3.5% in December to 4.6% in January.

Expecting Rebound in Consumer Spending and Boost to Q1’s Real GDP

We attribute the dip in consumption to inclement weather conditions during January. Moreover, consumer spending experienced a notable revision in December, m/m rates were adjusted upward from 0.7% to 0.8%. Consequently, we reasonably anticipate consumers to spend more freely in February and March.

This increased expenditure will likely contribute positively to real GDP growth, potentially moving it closer to our initial predictions of between 1.5% and 2.5%.

Conclusion and Bottom Line

In summary, despite the latest data downgrades and weakening economic indicators, we remain committed to our resilient-economy thesis for now. Although there are valid concerns about the state of domestic demand and trade dynamics, our confidence in the economy’s resilience persists.

While acknowledging the challenges posed by potential stagflationary pressures, we assign a subjective 20% probability to this scenario. Nevertheless, based on current data points, forecasts, and logical assessments of underlying economic factors, we believe Q1 real GDP will actually increase between 1.5% and 2.5%.