Real GDP Up; Real Final Sales Down/Was The Economy Stronger Or Weaker In The First Quarter?

This morning open on currency markets has seen some minor activity, mostly on the EURUSD pair as positive moves across the weekend drive support for the Euro.  With a settled Government now in Italy and stability in Greek parliament which is just about to clear the final hurdle to receive aid payments by cutting 15,000 civil service workers, we have seen the Euro jump 30 pips in the first 30 minutes of trade to 1.306 USD before gain were pared back in the last hour.  Gold has also started strongly after being sold off late on Friday; it’s up to 1465 USD an ounce after falling from highs of 1483 USD down to 1448 USD.

Friday’s main talking point was stateside as quarterly GDP missed estimates coming in at 2.5% versus median expectation of a figure of 3.1%.  The print surprisingly uneventfully traded on the currency and equity front, Wall Street was flat and the Australian dollar was stuck at between 1.026 and 1.029 USD for the entire US session.

Looking to today’s session, the quiet start is expected to continue as we have no economic data up for release and also we have a Chinese and Japanese bank holiday which will dry up regional volumes. With little fireworks expected on the equity front either we expect the water treading to continue through to the Italian bond auction later tonight. At the time of writing the Australian dollar is buying 1.0284 USD

Casual consumers of economic data, i.e. normal people, probably understand instinctively that the details behind the headline numbers matter. However, they can at least rest assured that such a large increase in the real GDP estimate as we had from the 4^th quarter to the 1^st quarter—from plus 0.4% to plus 2.5%–at least gets the direction right. Or, can they?

Several significant swings in the components of GDP are worthy of note, but I always look first at inventories. And, sure enough, an inventory swing dominates the latest GDP estimates. Inventory changes subtracted 1.52 percentage points from the real GDP estimate in the 4^th quarter while adding 1.03 percentage points to the 1^stquarter, for a net swing of 2.55 percentage points. Excluding inventory changes, real final sales increased 1.5% in the first quarter compared with an increase of 1.9% in the 4^th quarter. In other words, excluding inventory changes, real GDP actually declined from the 4^th quarter to the 1^st—the opposite direction from the headline number.

Inventory changes are notoriously hard to interpret. If businesses build inventories deliberately because sales have been good and are forecast to continue improving, then more inventory ‘investment’ should be counted along with other components of GDP. However, if inventories accumulate on the shelves because sales have fallen relative to expectations, then they will be a negative influence on future GDP and probably should be discounted. My point is that it is always useful to see what volatile inventories are contributing to GDP changes and make an educated guess as to whether their arithmetic contribution is misleading.

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