The Overnight Report: US Economy Shrinks


By Greg Peel

The Dow fell 44 points, or 0.3%, while the S&P lost 0.4% to 1501 and the Nasdaq dropped 0.4%.

There was a momentary gasp on Wall Street last night on the release of the first estimate of US December quarter GDP. Economists were expecting at least 1% growth, yet the result showed the US economy actually contracted by 0.1%. Suddenly the exuberant mood that has driven US stock indices towards their pre-GFC peaks became questionable. For a moment it looked as if the bottom could fall out from under the world.

But it didn't. If this had been 2010, 2011 or even early 2012 ? years in which a "double dip" was Wall Street's gravest fear ? the stock indices would have free-fallen on the news. But this is 2013, and in 2013 Wall Street has come to appreciate that the Fed will do whatever it takes. And when the numbers are broken down, and all is taken into account, it was not a result which will ultimately derail the rally.

Firstly, this is only a first estimate. The first estimate takes numbers from the first month of the quarter, in this case October, and extrapolates them across the three months for a quarterly result. In a month's time the second estimate will add in November and re-extrapolate. Then in another month December will be added. Even then, by the time the March quarter result is being guessed at, the December result can still be revised ? significantly. We recall that the previous September quarter result started quite low and was quite sharply revised up to 3.1% growth.

Secondly, the December quarter featured two exogenous factors ? Hurricane Sandy and the height of fiscal cliff fears. Before Christmas, many a business, if asked, was quick to suggest it would not be hiring/investing/buying in stock until the tax implications of Cliff were clear. Indeed, a fall in inventories was one of the main drags on the number. As was a fall in military spending from the government. On the other hand, other important private sector segments of the result were mostly pleasing. The housing market improved, as we know, and consumer spending was positive. Indeed, on a year on year basis the US economy grew at 2.2% in 2012 after growing 1.8% in 2011 and 2.4% in 2010. A similar rate is expected in 2013.

If no more than a similar rate is expected, why are US stocks suddenly pushing back towards their highs? Because the stock market is a leading indicator, pricing in forecast economic performance not just for this year but beyond. With the Fed playing backstop, the housing sector in recovery and the rest of the world not imploding, Wall Street is sufficiently confident that a recovery is under way.

On the subject of the Fed, however, I had noted this week that basically every Fed statement release post-GFC the market has been looking for clues of easing, and more easing. But for this statement the market was ready to look for signs of an exit strategy ? an easing of the easing ? to corroborate the stock market rally and the positive expectations thus implied. As soon as the negative GDP number came out, nevertheless, it was a case of "as you were". And the Fed delivered, reaffirming its ongoing asset purchase program (QE) and zero interest rates at least until the US unemployment rate falls to 6.5% from its current 7.8%.

On the subject of jobs, last night the ADP report suggested 192,000 new private sector jobs were added in January, exceeding forecast consensus of 173,000. While the ADP number has proven an often wildly unreliable indicator of the official non-farm payrolls result, the general trend of higher numbers over recent months adds weight to the recovery case.

At the end of the day, for the Dow to fall only 44 points on the release of the first negative US GDP result since the GFC recession is quite miraculous if we consider just how panicked and flighty Wall Street has been in recent years.

The US dollar index fell 0.4% last night to 79.26 as we might expect from a weak GDP result. Or more realistically, what we might expect from the promise of ongoing money printing for a while just yet. On that basis, gold jumped US$13.80 to US$1677.10/oz.

Base metals suddenly awoke from a lengthy slumber and jumped around 2% on average in London. The US economy may have contracted, but more US dollars means higher commodity prices by mathematical default. The oils ticked higher yet again, with Brent up US56c to US$114.92/bbl and West Texas up US40c to US$97.97/bbl. Iron ore is up US$1.00 to US$149.40/t.

By rights we should also have seen a stronger Aussie on a weaker US dollar, and on a reaffirmation that Aussie yields are still worth chasing, but the Aussie is down 0.5% to US$1.0410. Julia just gave us an unprecedented seven and a half months of uncertainty (and pain).

And by rights the US ten-year bond yield might have fallen last night on the weak GDP given it has risen steadily to this point, but confirmation the Fed will still be in there providing a safety net has conversely pushed the yield to just over the 2.00% mark for the first time since April last.

The SPI Overnight fell 5 points.

Facebook has just reported after the bell. Its shares are down 3% in the after-market.

Rudi will appear on the Switzer Report on Sky Business tonight at 7pm.

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