U.S. GDP soars in Q2…what next?

U.S. GDP soars in Q2…what next?

*Real GDP rose 6.5% annualized in Q2, below expectations, as anticipated strong gains in consumption and business fixed investment were offset by a further sizable inventory liquidation reflecting supply bottlenecks, a decline in residential investment despite strong housing demand and a widening trade deficit that suppressed domestic production. The ongoing inventory liquidation and decline in residential investment should be reversed and add significantly to GDP in coming quarters. Even with these negatives, real GDP rose 0.8% above its pre-pandemic level in 2019 (Chart 1). The recovery continues.

*Nominal GDP, the broadest measure of current U.S. dollar economic activity, surged 13.0% annualized in Q2 (and 16.7% yr/yr), as the GDP price index rose 6% annualized (4.0% yr/yr). The PCE price index rose at a 6.0% quarterly pace (4.0% yr/yr). These quarterly increases in the price deflators are the highest since 1982. Nominal GDP is now 4.7% higher than its pre-pandemic Q4 2019 level.

*What happens next? While the pace of expansion will obviously slow from its recent rapid recovery pace, we project continued healthy growth, well above potential, and further gains in labor markets, where recovery has lagged GDP. Product demand growth has exceeded businesses’ ability to produce, and, in coming quarters, businesses will increase production to meet rising demand and replenish inventories. Similarly, home builders have been unable to meet demand and both home construction and spending for home improvements are expected to rise. Both of these factors are expected to add sizably to GDP in coming quarters.

With the exception of higher inflation, all of the factors supporting continued healthy growth in domestic demand and production are positive. There is significant pent-up demand; personal savings is approximately $2.5 trillion above pre-pandemic levels; the unprecedented pipeline of fiscal and monetary stimulus will continue to fuel growth in aggregate demand, and policies will remain easy; recovering global economies are lifting demand for U.S. exports; and confidence is high. The probability of sustained healthy growth significantly outweighs the probability of a quick deceleration to the modest pre-pandemic 2% growth rate or below, and this GDP report boosts projections in coming quarters.

*Real consumption grew 11.8% annualized, with a continued strong 11.6% quarterly annualized increase in purchases of goods and 12% on services (Chart 2). Consumption of motor vehicles, recreational goods, and others rose strongly. Goods consumption is now a stunning 21.4% higher than its Q4 2019 level, while the strong increase in consumption of services lifted it a fraction above its pre-pandemic level. In the services sectors, the reopening of the economy generated a surge in consumption for services in transportation (37.6% annualized), recreation (42.8%), and food services and accommodations (67.7%). Despite these gains, activity remains below pre-pandemic levels and are expected to recover further.

*Business fixed investment (BFI) for equipment and software rose 13.0% annualized and increased 10.7% in intellectual property, while investment in structures fell 6.9%, continuing its softness (Chart 3). BFI now exceeds its pre-pandemic level and is expected to continue to rise, supported by low interest rates and costs of capital, strong product demand and cash flows and the need to replace old equipment and software and expand.

*Residential investment declined at a 9.75% annualized pace, subtracting from GDP, as construction was adversely affected by supply and labor constraints while sharp increases in home prices dented demand. Housing demand remains strong and spending on construction and home improvements is expected to rise in coming quarters.

*Final sales to all domestic purchasers rose 7.9% (despite the declines in residential investment and business investment in structures) and government purchases (consumption and investment) rose/fell 1.5% following its 4.2% jump in Q1. Of note, the growth of government purchases in coming years would receive a substantial boost from the American Jobs Act (on other words, infrastructure legislation) that is currently being deliberated on in Congress.

*The further sizable depletion of inventories in Q2—they declined $165.9 billon following their $88.3 billion decline in Q1—subtracted sizably from GDP (Chart 4). This further reduced the level of inventories relative to product demand, and a rebuild of inventories is certain to add to GDP in coming quarters.

*The trade deficit widened in Q2, as exports rose a solid 6.0% but imports rose faster (+7.8%). The wider trade deficit reduced domestic production relative to demand (Chart 5).

*The recovery in GDP has been much faster than even the most optimistic earlier forecasts. This has lifted profits and employment, but the recovery in labor markets has lagged GDP, constrained in part by shortages in labor supply. Wage gains have also accelerated despite the shortfalls of employment from pre-pandemic highs. If healthy growth is sustained, as we expect (and the Fed projects), profits will continue to rise, labor markets will recover (although we anticipate ongoing distortions in labor markets and further wage pressures), and underlying inflation pressures will mount, even as some of the temporary factors that have accentuated price increases dissipate (Inflation: Some Temporary Factors, but Underlying Pressures Mount, June 18, 2021).

Chart 1: Real GDP

Chart 2: Real Consumption of Goods and Services

Chart 3: Real Business Fixed Investment

Chart 4: Change in Inventories

Chart 5: Real Exports and Imports

Mickey Levy, mickey.levy@berenberg-us.com

© 2021 Berenberg Capital Markets, LLC, Member FINRA and SPIC

Remarks regarding foreign investors. The preparation of this document is subject to regulation by US law. The distribution of this document in other jurisdictions may be restricted by law, and persons, into whose possession this document comes, should inform themselves about, and observe, any such restrictions. United Kingdom This document is meant exclusively for institutional investors and market professionals, but not for private customers. It is not for distribution to or the use of private investors or private customers. Copyright BCM is a wholly owned subsidiary of Joh. Berenberg, Gossler & Co. KG (“Berenberg Bank”). BCM reserves all the rights in this document. No part of the document or its content may be rewritten, copied, photocopied or duplicated in any form by any means or redistributed without the BCM’s prior written consent. Berenberg Bank may distribute this commentary on a third party basis to its customers.

Member FINRA & SIPC
This email and any files or attachments transmitted with it may contain confidential or privileged information and are intended solely for the use of the intended recipient. If you are not the intended recipient, please do not copy, retain, disclose or use any part of the message or its attachments. Please notify the sender immediately by return email and destroy or delete any copies. Dissemination or use of this information by anyone other than the intended recipient is unauthorized and may be illegal. Communications by email cannot be guaranteed to be secure or error-free. Emails and their attachments are subject to being intercepted, becoming corrupted, getting lost or delayed, or may contain viruses. Therefore, neither the sender nor Berenberg Capital Markets LLC (BCM) accepts any liability for any errors or omissions in the content of this message or problems in its transmission, including those arising as a result of its transmission over the internet.
BCM does not assume liability for the correctness and completeness of all information given and/or attachments contained herein. The provided information has not been checked by a third party, especially an independent auditing firm. BCM explicitly points to the stated date of preparation. The information given can become incorrect due to passage of time and/or as a result of legal, political, economic or other changes. BCM does not assume responsibility to indicate such changes and/or to publish an updated document. Any document(s) or attachment(s) is meant exclusively for institutional investors and market professionals, but not for private customers. It is not for distribution to or the use of private investors or private customers.
In light of upcoming regulatory changes, please be informed that BCM will continue to share information with you until unsubscribe@berenberg-us.com receives your termination/deletion request. For more information about the General Data Protection Regulation (GDPR) and our privacy policies please refer to https://www.berenberg-us.com/legal-notice. BCM reserves all the rights in this communication. No part of this communication or its content may be rewritten, copied, photocopied or duplicated in any form by any means or redistributed without BCM’s prior written consent.
The information contained herein and sourced may have been adopted from various news sources, for example, Bloomberg, Reuters, Street Account and various other sources. BCM does not claim accuracy, completeness, timeliness, suitability, or otherwise regarding all the information on the securities, stock markets, or developments referred to within. On no account should the Content be regarded as a substitute for the recipient procuring information for himself/herself or exercising his/her own judgments. BCM is not responsible for any recipient(s) use of this information. This Content is not a solicitation or an offer to buy or sell any of the securities contained herein. This information does not constitute a recommendation or take into account the particular investment objectives, financial situations, or needs of clients. Clients should consider whether any advice or recommendation in this Content is suitable for their particular circumstances and, if appropriate, seek professional advice, including tax advice. The price and value of securities which may be referred to in this Content and the income from them may fluctuate. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur. Fluctuations in exchange rates could have adverse effects on the value or price of, or income derived from, certain securities.