Friday, October 23, 2015

Merrill on Q3 GDP and Headwinds

by Bill McBride on 10/23/2015 08:00:00 PM

The advance estimate for Q3 GDP will be released Thursday October 29th. Here is Merrill Lynch's forecast:

The economy has faced some strong headwinds this year, including a sharp rise in the dollar, weaker-than-expected global growth and sharp cuts in oil sector investment. Further, the economy is in the middle of an inventory correction. Weaker data, particularly for inventories, has contributed to lower GDP tracking, and we are now incorporating that weakness into our official forecast, cutting 3Q real GDP growth by 0.8pp to 1.2%. This lowers 2014 annual GDP growth to 2.4% from 2.5%. Looking past trade and inventories, domestic demand is expected to remain strong, rising by 3.5% in 3Q 2015, and by 3.0% in 2015 as a whole.
And on headwinds for the U.S. economy:
First, while the economy faces new global headwinds, the fundamental backdrop for the domestic economy has improved significantly. Post-crisis deleveraging has largely run its course. The housing and banking sectors are back on their feet. And Washington is no longer a major source of austerity and confidence shocks: Federal and state and local fiscal policy has shifted from a 1% or higher GDP headwind to a small tailwind and Americans have learned to largely ignore the budget battles in Washington. In our view, the new global headwinds—a strong dollar, weak growth in emerging markets and weak commodity prices—have less impact on US growth than the fading domestic headwinds –deleveraging, crippled banking and housing sectors and fiscal shocks.

Second, it is important to get the timing of the various shocks right. In our view, most of the hit to growth from global developments has already happened. The strong dollar is an ongoing drag on growth, but model simulations suggest a hump-shape pattern, with small effects last year, a peak drag on growth this summer and diminishing drag in the quarters ahead. On a similar vein, the biggest hit from the collapse in oil prices is behind us, with the collapse in mining investment in the first half of the year. Going forward, we expect a small net effect from low prices as a slow decline in mining related activity is offset or more than offset by consumers spending more of their savings from lower gas prices. The same applies to the inventory adjustment: almost all of the correction came in 3Q. The only shock that builds, rather than diminishes, going forward is the trade and confidence shocks from weakness in China and the rest of emerging markets. Our hope and expectation is that these effects will be small.
The future is bright!