The Most Bullish Bank On Wall Street May Cut Its GDP Forecast As Soon As Next Week

Joe Lavorgna

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Deutsche Bank has been one of the longest holdouts in terms of keeping its GDP forecasts steady in light of deteriorating data.But even it might be getting ready to chop, as its chief economist Joe LaVorgna explains:

 We are currently projecting +3.8% on Q1 real GDP growth, but we are worried that in light of recent weakness in February construction spending and March unit motor vehicle sales, we are about one percentage point too high on last quarter’s output. This is based on our bottom up tally of the high frequency data available thus far.  However, other useful metrics for gauging GDP growth strongly suggest growth could easily be in the high 3% range, if not higher. For example, the manufacturing ISM survey averaged 61.1 last quarter, the best showing since Q3 1983 (66.8) when real GDP expanded by 8.1%. About half of our Q1 real GDP estimate is coming from faster inventory accumulation, broadly consistent with what the ISM is suggesting. We only have one month’s worth of reported inventory data thus far in Q1. The February data will be reported next week. We do not want to play “elevator economics”—cutting our forecast at the first sign of weakness and then subsequently reversing course if the data then surprise to the upside, as the ISM seems to be suggesting.  Additionally, the unemployment rate has been falling hard.  This almost always happens when the economy is growing at an above-trend pace.  Case in point, real GDP grew 2.8% in 2010 which pushed the unemployment rate down 0.4%. This implies that potential GDP is only 2%. How so? Historically for every one percentage point the economy has grown above trend, the unemployment rate has declined by half as much; this implies potential growth of only 2% (i.e. 50% of the difference between 2.8% 2010 real GDP and 2.0% underlying trend equals 0.4%). Last quarter the unemployment rate averaged 8.9%, down a staggering 0.7% from Q4 2010. This simple rule literally implies 4.8% annualized Q1 real GDP. While this may seem extreme, we should note that the few times the unemployment rate fell by 0.7% in a given quarter, quarterly real GDP growth averaged an astounding +7.9%. This makes us hesitant to reduce our Q1 real GDP forecast much, if at all. 

However, it is ultimately the high frequency data that are best at estimating a given quarter’s growth rate. Next week’s data calendar will provide us with significantly more information on Q1 output. The prospect of upward revisions, which has been the pattern recently (private payrolls, retail sales and industrial production have all been revised higher) could significantly alter the outlook for the quarter. This would be the natural time to make any near term adjustment to our forecast. In terms of economic releases to watch, we get the February international trade report on Tuesday. We expect a modest narrowing in the trade deficit (-$43.0 billion forecast vs. -$46.3 billion previously), because we assume the rate of import growth slows a bit from a rapid +83.7% annualized gain in January. On Wednesday, we get March retail sales where we are projecting a +0.8% headline gain and a +1.0% reading excluding autos. Note that our ex autos ex gas forecast is +0.7%. Later on Wednesday we get February business inventories, which are anticipated to be up 1.0%. On Friday we get industrial production; we are looking for a 0.5% headline increase and a solid 2.0% increase in production of computers and electronic products, the key component the BEA uses to estimate capex, which we project near +20% annualized in Q1.