Is the U.S. economy poised for a third-quarter rebound?
That’s a forecast that some analysts are making, which would spell trouble for the bond market, which has been predicting the opposite. But the fixed-income set suffered a mild loss of confidence in Tuesday’s session, and in the process lent credence to the idea that the rate of growth in GDP for the third quarter will top the second-quarter’s pace.
The yield on the 10-year Treasury Note reversed course yesterday in no uncertain terms, rising to 4.78%, up from 4.73% on the previous close. It was the biggest one-day selloff in the 10-year in nearly two months (bond yields and prices move inversely).
Among those leading the charge for reassessing the prospects for economic growth is David Gitlitz, chief economist at TrendMacrolytics. In a note sent to clients yesterday, Gitlitz warned that the recent rally in the bond market was destined for a rude awakening as evidence of a third-quarter revival mounts in the coming weeks. The real opportunity in bonds, he wrote, “is on the short side — an opportunity that will crystallize when the evidence of reaccelerating growth and continuing inflation pressures become utterly unmistakable, and when there can be no further denial that the Fed’s next rate move will be higher, not lower.”
For the moment, however, the reported numbers show only an economy that’s slowed considerably. The quarter-on-quarter rise in U.S. GDP was 0.7%, or half as fast as the first-quarter’s pace. But the slowdown is set to reverse course in the third quarter, or so the OECD projects, with GDP advancing by 0.9% once the final tally for the July-through-September is published.
The notion that the economy is set to bubble a bit more than expected has also been getting a boost lately as oil prices have tumbled. In mid-July, crude briefly broke above the $80 a barrel mark–an all-time high. Yesterday, the October contract for oil closed in New York at just over $68.
The latest catalyst for thinking that oil may fall even further is the news of a major oil find in the Gulf of Mexico–a discovery that some say may boost U.S. reserves by 50%. Even if that optimistic projection turns out to be true, it won’t have much impact on reducing America’s dependence on foreign oil. But for the moment, the prospect of lower energy prices supports the belief that third-quarter economic growth could surprise on the upside.
Perhaps, although the slowdown in housing remains the big unknown. Even most optimists on the economy concede that the reversal of fortunes in housing is keeping expectations in check. And for good reason. The latest warning sign for real estate came by way of yesterday’s update from the Office of Federal Housing Enterprise Oversight (OFHEO), which reported that home prices “fell sharply” in the second quarter. “Appreciation for the most recent quarter was 1.17 percent, or an annualized rate of 4.68 percent. The quarterly rate reflects a sharp decline of more than one percentage point from the previous quarter and is the lowest rate of appreciation since the fourth quarter of 1999,” an OFHEO press release advised.
Ed Yardeni, chief investment strategist for Oak Associates, has been bullish on the stock market for some time but admits in an email to clients yesterday that the housing bubble is “certainly losing air.” In fact, he sees more real estate stumbles coming, including another downshift in home sales. “Rising mortgage rates and high home prices have depressed demand,” he explained. “Both new and existing median home appreciation rates have peaked, so would-be buyers aren’t racing to purchase homes because they are more concerned that prices might move lower than higher.” Meanwhile, Yardeni observed that large- and mid-cap equity forward earnings projections are “edging down slowly” while the outlook for small-cap stocks is “weakening fast.”
Nonetheless, Yardeni doesn’t think a housing recession would trigger the same in the economy overall. “Construction spending remains in record territory as a sharp drop in residential investment has been offset by big gains in nonresidential and public construction spending over the past year,” he reasoned.
Gitlitz made a similar argument in defense of his prediction of ongoing economic strength:
The cooling housing market has been a linchpin for hopes of a broad economic deceleration. But the latest GDP data offers no support for that notion. On the contrary, while residential investment accounted for a -0.63% drag on the growth rate, this was nearly entirely offset by a 0.6% boost to growth from nonresidential structural investment.
Nonetheless, even Gitlitz doesn’t expect the Fed to start hiking rates again when the FOMC meets next week on September 20. That, he predicts, will have to wait until the October 24/25 meeting.
Indeed, the Fed funds futures for October are anticipating that next week’s Fed meeting will hold rates steady at 5.25%. Mr. Market, in short, needs more convincing that stronger growth awaits.