Economic Newsletter

July 2014

 

Welcome to the CEO's monthly economic newsletter. The newsletter provides a basic narrative overview of recently published economic indicators for your reading pleasure. You should not rely on this information when making investment decisions, but rather seek professional advice from qualified investment advisors.

 

In case you may not have heard, first quarter Gross Domestic Product (GDP) was revised from -1.0% to – 2.9% representing the third and final revision for the quarter. We just witnessed the largest downward revision between the second and third GDP revisions since the Commerce Department began keeping records in1976. The reason the calculation of GDP is revised 3x is that some economic readings that make up the total come out later than others, so it takes awhile to compile the data.

 

The Bureau of Economic Analysis divides GDP into 4 major components: Personal Consumption Expenditures, Business Investment, Government Spending, and Net Exports of Goods and Services. Overall, nearly 70% of what the country produces is for personal consumption, which is critical for economic recovery. This includes durables goods like autos and furniture, and nondurable goods such as food, clothing and fuel. It also includes financial services and healthcare services, which represent the largest part of personal consumption making up 48% of total GDP.

 

The “services” component of personal consumption received the most revisions, which served to reduce personal consumption expenditures by 2.1% for Q-1. (Apparently they had initially overestimated the economic benefits of “Affordable Healthcare”.) The other major negative revision came from increased negative Net Exports, thereby lopping off another .6 percentage points from GDP. Offsetting, in part, some of the aforementioned revisions were a few positive adjustments to both residential and non-residential investments. Government spending was not revised.

 

What does this mean for Second quarter GDP? Most economists, and the Federal Reserve, believe we will see a substantial rebound in Q-2. Just how much is anyone’s guess. Most seem to believe it will come in at +3.0% to 4.0%, while others believe it could be approaching 5.0%. The Federal Reserve is forecasting overall growth in GDP for 2014 to be around 2.10% to 2.30%. To accomplish that objective, GDP will need to average about 3.77% to 4.03% for the remaining 3 quarters of 2014. That is a tall order, inasmuch as we have not hit that number since before the Great Recession. Regardless, employment is clearly strengthening which will give rise to more personal consumption, the primary driver of GDP.

 

On the employment front, Non-farm payrolls rose an impressive 288k in June, surpassing the median expectation of 215k on Bloomberg, and was the fifth consecutive +200k employment report. The unemployment rate dropped from 6.3% to 6.1% in June, a near six-year low. Average hourly earnings also improved by 0.2% in June, up 2.0% over the past 12 months.

 

Interest rates remain stable. You might find it interesting that the U.S. 10-Year Treasury yield at the end of June was 2.52%, still well above Germany’s 10-year equivalent (1.26%), France’s (1.70%) and Spain’s (2.67%), and well below Italy’s (2.80%). Given the issues that some of these countries face economically, most experts believe our interest rates will remain low until worldwide rates move materially higher. After all, given the option of investing in a 10-year French bond yielding 1.70% versus 2.50% or higher for the same term here in the US, there is no reason to push rates up here to attract money for our Treasuries.

 


Dennis A. Long

President & Chief Executive Officer

Pacific Financial Corporation



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