Though the debt ceiling impasse stole headlines, a report noting a lack of economic growth in the first half of the year warrants attention. We evaluate whether the disappointing report will cause the Federal Reserve to announce another round of stimulus.
The nation is understandably preoccupied with a circus on Capital Hill that refuses to leave town. There are two primary beneficiaries: television news channels and the economy. The former is enjoying a ratings spike as millions appear glued to watching the second by second countdown to August 2nd’s deadline. The latter is simply thankful to sidestep the spotlight and its associated scrutiny.
In what would have otherwise been the primary news event of the day, the Bureau of Economic Analysis statistics dropped a press release with a host of economic data at 8:30 this morning. Unfortunately the report was highly anticipated or perhaps it would have been largely forgotten thanks to the now routine breaking news from Washington that in fact, there is still no progress to report.
The press release offered both a revision to economic growth in the first quarter and an initial estimate for the second quarter. The prevailing view among Wall Street and Federal Reserve economists has been that economic growth in the first half of the year was admittedly tepid. The release of the second quarter GDP this morning served to quantify “tepid,” if not provide an underlying suggestion that the adjective be replaced by “downright miserable.” First quarter growth, last thought to be 1.9% was revised down to only 0.4%. An initial guess as to the pace of the recovery in the second quarter is for growth of 1.3%.
The magnitude of the revision is startling for a host of reasons, the first of which is a series of questions concerning how previous expectations could be so wildly misleading. With those concerns unlikely to be resolved, the prudent investor instead turns his attention to the primary question: Will this anemic economic growth be enough to spur an additional round of monetary stimulus from the Federal Reserve?
Probably not. The Federal Reserve has indicated that embarking on an additional round of stimulus (referred to as quantitative easing, part three or “QE3”) brings its own concerns and thus, according to Atlanta Fed President Dennis Lockhart, a “very high bar” must be met before the release of additional stimulus.
Defining a “very high bar” is difficult, but we expect the threshold includes four primary components: continued deterioration of economic growth, high unemployment, contained inflation and lower stock prices. Though economic growth and unemployment have been disappointing, one must remember that a majority of Federal Reserve committee members expect a robust recovery in the second half of the year. It is therefore too early to conclude that current deterioration in those two components will provide the catalyst for further monetary easing. The inflation gauge is volatile but many commodity prices have retreated from their April highs. Stock prices have been generally resilient but have come under pressure amid stalled debt ceiling negotiations.
The situation remains fluid, prompting investors to be sensitive to the release of pending economic data as they try to anticipate the Federal Reserve’s next move. Will the Fed hold to its belief of an imminent, self-sustaining recovery or determine a third round of assistance is needed to support a fragile economy?
The prudent investor proceeds cautiously, recognizing that both continued economic weakness and lower stock prices will precede any meaningful discussion of additional stimulus.