I recently wrote an article talking about US GDP growth expectations for 1Q16 in accordance with the GDPNow model from the Federal Reserve Bank of Atlanta. According to the latest forecast by the model (April 8, 2016), US GDP growth for 1Q16 is likely to be 0.1% with growth expectations having slumped significantly in the recent past as indicated by the chart below.
While the GDPNow model shows that US is almost on the brink of recession, there is another forecasting model from another Federal Reserve Bank that paints a significantly different picture.
The Federal Reserve Bank of New York issues the Nowcasting Report and the report tracks the evolution of the bank’s nowcast of GDP growth and the impact of new data releases on the forecast.
As of April 8, 2016, the Nowcasting Report expects 1Q16 GDP growth at 1.1% and the chart below gives the forecast evolution since November 2015.
With two different forecasts predicting a broad range, it remains to be seen which forecast is closer to actual GDP growth. However, I have the following points to mention –
First, looking back at the tracking record for the GDPNow indicator, the error from first BEA advance estimates has ranged from (+/-) 0.1% to (+/-) 2.4%. While the margin of error has been minimal in the last four quarters, it is entirely likely that 1Q16 GDP can be higher than what GDPNow estimates.
Second, the 10-year Treasury bond yield is currently at 1.78% and is below the yield levels when fed increased rates for the first time since the crisis in December 2015. This is a potential indicator of the point that GDP growth will certainly be sluggish if not 0.1%.
Third, the dollar index is currently at 94.6 with YTD16 returns of negative 4.1%. With the dollar weakening, the markets are expecting no rate hike in the foreseeable future and a potential rate cut if economic weakness sustains. In the last speech, Yellen has clearly mentioned that the fed is prepared to cut rates again, if needed. Just this mention by Yellen shows that policymakers are wary of growth outlook.
I also want to present another economic another economic indicator from the Federal Reserve Bank of Philadelphia – The Aruoba-Diebold-Scotti Business Conditions Index.
As the chart below clearly shows the business conditions worsened in February and March 2016 before recovering in the recent past. I therefore believe that 1Q16 GDP growth numbers are more likely to be closer to 0.1% than 1.1%.
Probably this explains why 1Q16 GDP is likely to be sluggish and also explains why equity markets might be showing some resilience with economic conditions improving again.
However, I would still remain cautious on equities and I have mentioned in the recent past that I expect 10% to 15% correction for the index in the next 3-6 months. Even if there is no recession, sluggish global growth can potentially imply that corporate earnings recession sustains and that factor can translate into correction for equities.
In conclusion, there is little doubt that economic growth for 1Q16 is likely to be sluggish and it will force policymakers to maintain status-quo. Depending on 2Q16 economic conditions, I expect the fed to make the next move in the second half of 2016. In all probability, it is likely to be a rate cut back to zero levels.