Tomorrow We Get The First Look At Q2 GDP, And Forecasts Are Not Optimistic

Market economists predict on average that the U.S. economy grew 1.0% at an annualized pace in the second quarter after posting 1.8% growth in Q1. Personal consumption is expected to have risen 1.6% after a 2.6% advance in Q1.

The main culprits for the slowdown in growth: sequestration of the federal budget earlier this year and an attendant knock to consumer spending.

"The weakness in the first half of the year owes in part to fiscal tightening which resulted in a sharp drop in government expenditures and likely weighed on consumer and business expenditure," writes the U.S. economics team at BofA Merrill Lynch in a recent report. "Consumers responded with a lag — we expect real consumption growth of 1.8% in 2Q compared to the 2.6% gain in 1Q. We also forecast slow growth in capex and a slight contraction in nonresidential structures investment."

Société Générale economists Brian Jones and Aneta Markowska are also on the bearish side of the consensus estimate for Q2 GDP.

"We expect the Bureau of Economic Analysis to report that that inflation-adjusted business activity expanded by a paltry 0.4% annualized in Q2, well off the winter quarter’s less-than-inspiring 1.8% pace," say the SocGen economists. "Indeed, a marked slowdown in inflation-adjusted consumer spending from 2.6% to 1.4%, along with sizable drags from slower stock-building and the external sector, points to a sharp slowdown in inflation-adjusted business activity in the spring."

However, many are quick to point out that the GDP release is a lagging indicator.

"Our economists had long predicted weakness over Q2, and expect data to strengthen this summer," says Société Générale head of rates and forex strategy Vincent Chaigneau.

Perhaps of greater note are the revisions to previous quarters that will accompany the Q2 GDP report.

"It would be a big mistake to ignore the comprehensive benchmark revision to GDP on July 31," say BAML economists Michelle Meyer and Alexander Lin. "We think the revisions will be significant, resulting in a higher level of GDP, personal income and the savings rate."

Meyer and Lin preview what to look for in the revisions included in tomorrow's report:

• The level of GDP will be revised higher over the history of the sample, likely in the order of 3.0 [percentage points]. We believe the revision will be pro-cyclical and therefore make the recessions look modestly deeper and the recoveries appear stronger. In particular, already-released revisions to source data imply an upward revision to 2012.
• Personal income will also be revised higher. However, it will likely be adjusted to be less volatile, likely smoothing the most recent business cycles.
• The saving rate will be revised higher, likely in the order of 2 to 3 [percentage points]. This could boost the current rate from 3.2% to as high as 6%. We think the revision will be notable over the past cycle, showing greater precautionary saving in response to the financial crisis. The revisions will make the data more comparable to the Flow of Funds (FOF) accounts and help to align the savings rate measured by the FOF and NIPA.
• An upward revision to GDP growth will bring the trend in GDP more in line with the recovery in jobs. It therefore implies an upward revision to the level of productivity, but in particular we look for an upward revision to productivity growth in 2012.
• Corporate profits are likely to be little changed (with a risk of a small downward revision), but the revised series should be less volatile.
• The PCE deflator will be subject to revisions as well, but we have little information regarding the direction or the magnitude. In past benchmarks, the revisions to the deflator have been marginal.

"This has the potential to alter policymakers’ perceptions of both the depth of the last economic downturn and the speed of the recovery," says Deutsche Bank strategist Jim Reid. "The last comprehensive benchmark revision occurred in July 2009, just as the economy was emerging from recession. Given that we have seen a steady pattern of upward revisions to nonfarm payrolls, we believe there is a decent probability that real GDP growth will be revised higher over the past couple of years."