On Friday, the Commerce Department unveils the government’s first estimate of economic growth for this year’s first quarter. The consensus outlook calls for a hefty rise of 5.0%, according to Briefing.com. If that proves accurate, the optimists will no doubt celebrate the rebound from the dismal 1.7% rise logged for the fourth quarter. Indeed, 5.0% would be the fastest quarter growth since the 7.3% advance in 2003’s third quarter.
Meanwhile, the shadow from the previous number still looms. The fourth-quarter GDP report, you may recall, sent shivers throughout Wall Street and Main Street. The sky was finally falling, and recession loomed, or so it appeared from the sharp slowdown posted in the last three months of 2005 vs. the previous quarter.
Statistically, who could argue? The thin 1.7% advance in real GDP for the fourth quarter was a world below the 4.1% climb that prevailed during July through September. But as we wrote back in January, when the fourth-quarter number was initially released, there were more than a few skeptics claiming disbelief that the economy could be as weak as the Commerce Department said it was. A modicum of justification for the doubts came with each of the two subsequent 4Q GDP revisions. Once the numerical dust cleared, the 1.1% rise in GDP first reported migrated upward to the final 1.7%.
Still, 1.7% doesn’t suffice to keep the pessimists at bay. The task of regaining optimism’s commanding heights necessarily falls to the shoulders of this Friday’s 1Q GDP number. If the consensus holds, the coming weekend promises to be one when cries of “I told you so” echo throughout the land.
In fact, the optimism would jibe with the bond market’s bias so far in 2006. When 2005’s advance 4Q GDP report was released on January 27, the benchmark 10-year Treasury Note closed the day’s trading session at just a hair over 4.5%. As of Friday’s close, the “riskless” government bond changed hands at a considerably higher yield of just over 5.0%. Conviction that the economy will continue humming along could hardly look clearer through the eyes of the fixed-income set.
Ah, but there’s a complicating glitch that was dispensed last Thursday in the form of the Conference Board’s Leading Economic Indicator. As we noted on Friday, the LEI suggests that the economy’s due to slow.
The bond market apparently doesn’t agree, but Paul Kasriel thinks it may be time to rethink conventional wisdom when it comes to deciding where the path of least resistance lies on the economy’s immediate future. The “steady downtrend in the year-over-year growth in the LEI has been a warning of an imminent recession,” writes the director of economic research at Northern Trust in a research report published on Friday. Although the metric gets little respect, he notes that a “steady downtrend” in LEI has proven to be a reliable, if not quite perfect predictor of the onset of recession. There have been two notable exceptions, the last one coming in 1995. The reason that recession was averted 11 years ago, Kasriel opines, is that the Fed rushed to the rescue with interest-rate cuts.
Is that prescription warranted in the here and now? It’s a tricky question, in part because there have been a number of economic reports over the last few months that refute the idea that a stumble is imminent. All the more reason that all eyes will watch Friday’s 1Q GDP report for clues as to what comes next. To be sure, GDP reports are backward-looking snapshots, but influential nonetheless.
In any case, the futures market is anticipating another 25-basis-point hike in Fed funds, based on the May contract. That may be the final increase in the round of tightening that began in June 2004, or so the June 2006 Fed fund futures contract implies. But for those who read the future by way of LEI’s prism, there’s the question of whether even one more hike is too much.
Maybe Friday’s GDP report can offer some clarity.
© 2006 by James Picerno. All rights reserved.