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NBF_What BEA Revisions Mean for Fed_Economic Letter_20100820

NBF_What BEA Revisions Mean for Fed_Economic Letter_20100820

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August 20, 2010
ECONOMY AND STRATEGY GROUP – 514.879.2529Stéfane Marion,
Chief Economist and Strategist
: National Bank Financial (NBF) is an indirect wholly owned subsidiary of National Bank of Canada. National Bank of Canada is a public company listed on Canadian stock exchanges.
The particulars contained herein were obtained fromsources which we believe to be reliable but are not guaranteed by us and may be incomplete. The opinions expressed are based upon our analysis and interpretation of these particulars and are not to be construed as a solicitation or offer to buy or sell the securities mentioned herein
Canadian Residents:
In respect of the distribution of this report in Canada, NBF accepts responsibility for its contents. To make further inquiry related to this report or effect any transaction, Canadian residentsshould contact their NBF Investment advisor.
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NBF Securities (USA) Corp., an affiliate of NBF, accepts responsibility for the contents of this report, subject to any terms set out above. Any U.S. person wishing to effect transactionsin any security discussed herein should do so only through NBF Securities (USA) Corp.
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In respect of the distribution of this report to UK residents, NBF has approved this financial promotion for the purposes of Section 21(1) of theFinancial Services and Markets Act 2000. NBF and/or its parent and/or any companies within or affiliates of the National Bank of Canada group and/or any of their directors, officers and employees may have or may have had interests or long or short positions in, and may at any time make purchases and/or sales as principal or agent, or may act or may have acted as market maker in the relevant securities or related financial instruments discussed in this report, or may act or have acted asinvestment and/or commercial banker with respect thereto. The value of investments can go down as well as up. Past performance will not necessarily be repeated in the future. The investments contained in this report are not available to privatecustomers. This report does not constitute or form part of any offer for sale or subscription of or solicitation of any offer to buy or subscribe for the securities described herein nor shall it or any part of it form the basis of or be relied on in connectionwith any contract or commitment whatsoever. This information is only for distribution to non-private customers in the United Kingdom within the meaning of the rules of the Regulated by the Financial Services Authority.
This report maynot be reproduced in whole or in part, or further distributed or published or referred to in any manner whatsoever, nor may the information, opinions or conclusions contained in it be referred to without in each case the prior express written consent of National Bank Financial.
Topic of the week
The Q2 real GDP data published this past July 30came with a major revision of historical data by theBureau of Economic Analysis (BEA). Theeconomic analysts of the world were slack-jawedby the disappearance of $100 billion from U.S.GDP for 2010Q1. Consumption alone was reviseddown $134 billion. As a result, instead of being inexpansion territory, it turns out consumption isactually only midway up the recovery curve. As thelevel of resource utilization in the economy asbeen pegged back, this implicitly modifies theimpact of past monetary easing by the FederalReserve. On a more positive note, the level oflabour productivity in the U.S. seems to have hit awall in the short term. For the first time since thestart of the recession, the composition of GDPgrowth has been geared towards employmentrather than productivity. This said, if theunemployment rate does not begin to trend down,the Fed will have no choice but to step in onceagain.
Economic indicators review
(p. 6)
Things to watch
Economic calendar and significant earningsannouncements of the week ahead (p. 7)
Economic tables
(p. 8)
What BEA revisions mean for Fed
The Q2 real GDP data published this past July 30 camewith a major revision of historical data by the Bureau of Economic Analysis (BEA).
The economic analysts of the world were left slack-jawedby the disappearance of $100 billion from U.S. GDP for 2010Q1. Consumption alone was revised down $134billion. As a result, instead of being in expansionterritory, it turns out consumption is actually onlymidway up the recovery curve.
The labour market must begin creating enough private-sector jobs to bring down the unemployment rate.Otherwise, the Federal Reserve will not be able totolerate the situation, as it would ultimately constitute adisinflationary environment.
On a more positive note, the level of labour productivityin the United States seems to have hit a wall in the shortterm. For the first time since the start of the recession,the composition of GDP growth has been gearedtowards employment rather than productivity.
This said, as the level of resource utilization in theeconomy has been pegged back, this implicitly modifiesthe impact of past monetary easing by the FederalReserve.
If the unemployment rate does not begin to trend down,the Fed will have no choice but to step in once again.
Unfortunate “step back”
The U.S. recovery forged ahead in 2010Q2, with real GDPgrowing at an annualized 2.4%. However, in light of thelatest international trade statistics, this rate will be reviseddown sharply. U.S. domestic demand, though, willcontinue to accelerate markedly in excess of 4% at anannual pace.
August 20, 20102
-35-30-25-20-15-10-5051015202595 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
% (q/q, ann.)
1) Strong recovery in IME
Investment in machinery and equipment in real terms 
NBFG Economy and Strategy Group (BEA data via Global Insight)
 The strong recovery in investment in machinery andequipment (IME) is ongoing and, on a historical basis, isfar different from past episodes. As for inventoryrebuilding, the cycle does not seem over yet, as only $120billion of the $600-billion cumulative inventory reductionhas been restored. Even if we take into account the muchlower level of activity in the auto sector, there should stillbe room for a positive contribution to GDP in the secondhalf of the year.
-180-160-140-120-100-80-60-40-200204060801001201960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
NBFG Economy and Strategy Group (data via Global Insight)
2) Is inventory rebuilding cycle over?
Change in real private inventories (National Accounts)
Cumulative -$603B at annualrate during recession
$ billions
+$120Bso far
 This said, the Q2 real GDP data published this past July30 came with a major revision of historical data by theBureau of Economic Analysis (BEA).
Now you see it, nowyou don’t, and—presto--the economic analysts of theworld were left slack-jawed by the disappearance of $100billion from U.S. GDP for 2010Q1. Consumption alonewas revised down $134 billion. Besides seeking to predictthe future to the best of their abilities, economists, it wouldseem, must now also foresee the past!Thus, after taking two steps forward, U.S. consumptionhas just taken one step back. As a result, instead of beingin expansion territory, it turns out household spending isactually only midway up the recovery curve.
8,9609,0009,0409,0809,1209,1609,2009,2409,2809,3209,3609,40006Q1 06Q3 07Q1 07Q3 08Q1 08Q3 09Q1 09Q3 10Q1
$ billions
3) U.S. consumption: from expansion to recovery?
NBFG Economy and Strategy Group (BEA data via Global Insight)
Bureau of Economic Analysis revisions* by component as of 2010Q1Real consumption 
…household spendingis still almost 1% offpre-recession peak.Instead of being inexpansion…
GDP componentsRevisions in billionsof US$
Consumption-134Residential investment-23Nonresidential structures-27Equipment and software46Government-25Net exports38Inventories-31real GDP-100
* Components do not add up to overall GDP because data are chain-weighted.
 Following this revision, we lowered our growth projectionfor the U.S. economy in 2010 from 3.5% to 3.0% on anannual average basis. Though the drop is not a colossalone, the implications for the Federal Reserve’s scenarioturn out to be far more tangible, as we will see.
What, then, has Fed’s impact been?
 The data revisions have forced us to question part of theimpact that the Fed’s accommodating monetary policy hashad on the economy. As we already knew, when ahousing bubble bursts, the Fed’s purchase on the situationis nil in the early going. However, this time around, evenwith real rates at floor level, the housing sector as apercentage of the economy has not managed to bounceback as it did in previous episodes.
-6-5-4-3-2-10123456789101. 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
4) Fed has no purchase on housing sector
Real Fed Funds rate and ratio of residential investment to GDP 
Residential investmentas % of GDP (R)Real Fed Funds rate (L)
% of GDP
 The problem is all the worse in that the housing sector hasby far the greatest spill-over effects on economic activityas a whole. While the U.S. economy lost 6.1% of its jobsduring the recession, those lost in construction totalled25.6%, that is, more than four times what residentialinvestment represented as a percentage of GDP beforethe bubble collapsed. This very particular context is thereason the Fed is not able via interest rates to influencethe allocation of resources for the housing sector in thepresent recovery.
August 20, 20103
-1.6-1.4-1.2-1.0-0.8-0.6-0.4- 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
NBFG Economy and Strategy Group (Global Insight and BEA data)
% of total employment
5) When construction stalls
24-month change in construction employment as % of total employment 
 All and all, not only the Fed’s monetary policy has notraction on the housing sector immediately following theimplosion of a real estate bubble but, with the latest BEArevisions, the statistics show also that the Fed has hadless of an effect on the broader economy than initiallythought.
Bigger cushion than expected
This said, the BEA revisions also bore some good news.The household savings rate went from about 4% before to just over 6% after the revisions. This means that U.S.households raised their savings rate during the recessionmuch more than first estimated. Hence, U.S. consumersare deleveraging at a much faster pace than initiallyobserved. This is because, though consumption continuesto progress slightly, disposable personal income (DPI) ison the rise as well, having grown at an annualized rate of4.4% in Q2.
-10-8-6-4-202468102004 2005 2006 2007 2008 2009 2010
-4-3-2-101234506Q1 06Q3 07Q1 07Q3 08Q1 08Q3 09Q1 09Q3 10Q1 10Q3
% (q/q, ann.)
6) United States: will consumption growth be sustained?
NBFG Economy and Strategy Group (BEA data via Global Insight)
Real personal disposable income and savings rate Real consumption 
Real personaldisposable incomerose 4.4% in Q2…
Savings rateR.P.D.I.
…allowing savings rateto move in tandem withconsumption.For Q3 to register sameconsumption growth asQ2, monthly growth of0.15% is needed overnext three months……exactly the meangrowth since thebeginning of therecovery.
Hand-off inQ3 = 0.5%
 And the higher the savings rate, the less likelyconsumption growth will flag when DPI rises. This isreason for Federal Reserve Chairman Ben Bernanke tocheer, as he is counting on household consumptionexpenditures (seeing how DPI is expected to rise) tosustain the recovery. However, he is also counting onbusiness IME to pursue its run.In our opinion, though, the strong recovery in IME willsoon come to an end as the level of decoupling betweenconsumption and IME cannot persist much longer. Indeed,businesses are not short-sighted and, knowing thatconsumption growth will be soft in future, the economicincentive to invest heavily above and beyond thereplacement of capital stock depreciated during therecession will soon begin to wane.
Labour market: key factor ultimately
More than ever, our scenario projecting economic growthof about 3% in 2010H2 hinges ultimately on the U.S.economy’s capacity to create jobs. The July labour reviewwas clearly disappointing, with private-sector payrollemployment climbing only 71K and pulling its 3-monthmoving average down from 150K to 50K in the process.
-8-6-4-202468101990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010-900-800-700-600-500-400-300-200-100010020030007M01 07M07 08M01 08M07 09M01 09M07 10M01 10M07
7) United States: consumption supported by wage bill
Private-sector payrolls and 3-month moving average 
Even if private payrollsdisappointed in July…
Private-sector wage bill and personal consumption expenditures 
…wage bill is growing.
NBFG Economy and Strategy Group (data via BLS)
Thousands (m/m)% (q/q, ann.)
Wage billConsumption2.3%Private payrolls3-month M.A.
 Still, as both total hours worked and wages were up,wage-bill growth was strong in July, making for anexcellent hand-off in Q3 of 2.3% on an annualizedquarterly basis.As Chart 8 shows, we can hardly see how consumptioncould decline with the wage bill expanding.
-6-5-4-3-2-1012345607M01 07M07 08M01 08M07 09M01 09M07 10M01 10M07
EmploymentWage billNominal consumption
% (y/y)
8) Jobs data suggest sustained consumption
Growth in nominal consumption, wage bill and employment 
NBFG Economy and Strategy Group (data via BLS and BEA)
 From the point of view of the Federal Reserve, however,the analysis is different. The labour market must create

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