Weak US growth, but no default

illustration: DNB markets dealingroom

(01.08.2011) The financial markets were Friday negatively affected by disappointing US growth data. Flight to safety implied lower equity prices, lower government bond yields, higher gold prices and a record strong CHF. This development may turn today as the US parties agreed on spending cuts and a higher debt ceiling late on Sunday.

By Knut A. Magnussen, Senior Economist at DNB Markets

The US GDP data for 2Q, released on Friday, were a large disappointment. The annualized growth rate in 2Q was only 1.3% and the data for the first quarter was revised markedly downwards from 1.9% to only 0.4%. Furthermore the revised data also showed that the recession was deeper than earlier anticipated and that the recovery has been weaker than what the data so far have indicated.

In the second quarter private consumption did not grow at all, showing the weakest performance so far during the recovery. Consumer demand was hampered by higher petrol prices and by negative supply chain effects in the car market due to the earthquake in Japan. Both factors are most likely temporary and consumer demand will probably recover in the second half of this year.

Public demand was also weak and contributed negatively to growth for the third quarter in a row. This tendency will most likely continue. So far local authorities have been tightening their policies, but going forward also the federal authorities will cut spending considerably. This tightening (see below) will also dampen growth in 2012.

The weaker than expected data induced more flight to safety, as we have seen several times recently. The stock markets fell world wide, while government bond yields fell in the US and in Germany. In the FX market the CHF rose to new record strong levels vs the EUR and the USD.      
Most likely the market sentiment will turn more positive today due to the fact that the US political parties late on Sunday came to an agreement on (long term) spending cuts and a higher debt ceiling. The austerity plan implies spending cuts of around 1000 bill. USD, but no tax increases. The debt ceiling will be lifted by a 2400 bill. USD in two steps, which means there will not be a new debate on this issue prior to the presidential election late in 2012. Furthermore a bipartisan committee is going to work for a further tightening of 1800 bill. USD. The Congress will have to approve the agreement today.

Even if a default will be avoided, one cannot be sure that the US will avoid loosing its AAA-rating. However market reaction will probably be positive and the Asian stock markets have risen. There are more important US event this week that may show to which extent the markets have confidence in the savings plan ie. a large government bond auction is scheduled for Thursday.     
There are also important US data scheduled for this week. Today the ISM index for manufacturing for July will be released. The June reading surprised on the upside and the regional surveys for July points at a further improvement. However the levels of the regional indices are still low and consistent with an ISM at around 50.

Even more important is the payrolls report due on Friday. The June report was very negative and employment rose by only 18.000. For July and increase of 85.000 is expected and the unemployment rate iis expected to stay unchanged.

There are also rate meetings in BoE and ECB this week, but no rate changes ore new signals are expected. The ECB signaled in July that inflation will be monitored closely, pointing at another rate hike later this autumn.