Morning Report – Big GDP number 7/30/14

Markets are higher this morning on a strong GDP numbers. Bonds and MBS are selling off.

We will get the FOMC rate decision this afternoon. Since there are no economic forecast revisions and no press conference, I expect it to be a non-event with an announcement of another decrease in asset purchases and no change in interest rates. The interesting stuff probably won’t make it into the press release and we will have to wait for the minutes.

The advance estimate for second quarter GDP came in at 4%, a strong rebound from the revised -2.1% pace in Q1. The Street was at 3%. People were expecting a strong Q2 number as the first quarter number was depressed due to the weather and activity undoubtedly was pushed into Q2. Personal consumption came in at 2.5%, again a better than expected number. I would caution that the advance estimates of GDP have been WAY off lately – the advance estimate for the first quarter was +0.1% and the final number was -2.9% (subsequently revised up to -2.1% as the government made some baseline adjustments). Inflation came in at 2%..

The internals for the GDP number: big jump in consumption, especially durable goods and autos. Not surprising – the average age of a car in the US is something like 11.4 years, which is a record. Gross private domestic investment (in other words capital expenditures) rose by a lot. My suspicion is that was weather-driven. Government spending increased as well. Overall, the strong number should not have been a surprise given the strong data we have been seeing lately

Chart: GDP QOQ growth 1990 – 2014

GDP bloomberg

The ADP payroll number came in weaker than expected: 218k versus 230k. The Street is at 231k for Friday’s payroll number. Note that ADP uses a model to predict the number while BLS uses a sampling methodology. ADP’s number is designed to match the final BLS number, not the initial one, though it has been pretty spot-on the last couple months.

This strong economic data does kind of beg the question of whether the Fed is getting behind the curve. QE will probably end sometime this fall, but the Fed could find itself by the end of the year substantially at its inflation and unemployment targets, with rates still at zero percent and a balance sheet four times the size it should be. I think the Fed is fine with erring of the side of caution and doesn’t want to make the mistake the Bank of Japan did and tighten before the economy was hitting on all cylinders. I think the Fed will probably hold rates at or close to zero until we start seeing wage inflation. That will be the tell, IMO.

Mortgage Applications fell 2.2% last week as purchases rose .2% and refis fell 4%. Bonds were flat last week, and MBA has the average 30 year fixed rate mortgage flat at 4.33%, while Bankrate had it increasing from 4.27% to 4.33%.

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