Advance 2nd quarter GDP

The government released advace figures for 2nd quarter GDP this morning along with revisions to GDP data going back to 2003. Here's a link to the whole report. BEA

"Real gross domestic product -- the output of goods and services produced by labor and property located in the United States -- increased at an annual rate of 2.5 percent in the second quarter of 2006, according to advance estimates released by the Bureau of Economic Analysis. In the first quarter, real GDP increased 5.6 percent.

The price index for gross domestic purchases, which measures prices paid by U.S. residents, increased 4.0 percent in the second quarter, compared with an increase of 2.7 percent in the first. Excluding food and energy prices, the price index for gross domestic purchases increased 2.9 percent in the second quarter, compared with an increase of 3.0 percent in the first."

Consensus among economists had been for a 3.2% increase so this number is slightly less than expected. The core price index increase of 2.9% is good news for those waiting for an end to Fed rate hikes. The slowdown, along with the relatively benign inflation figures, should allow the Fed to stand pat at the next meeting on Aug 8th. Fed Funds futures contracts are now pricing in about a 30% chance of a rate hike at that meeting, but I think that the chances are closer to zero. In my opinion, the Fed has to be very careful about overshooting and pushing the economy into recession. The inflation figures are lagging indicators and even if the headline numbers continue to increase for a while, I suspect inflation has already peaked, at least in the short term. Longer term inflation expectations will be determined by future Fed policy, not past.

Big contributors to the slowdown were a drop in durable goods, residential fixed investment, and federal government spending. The drop in residential fixed investment is not surprising, but the drop in government spending is quite a mystery to those of us who worry about the deficit. The report states that overall federal government spending dropped 3.4% with defense spending dropping 1.0%. Really? Why do I think that number will be revised higher in future reports?

The market, at least for now, seems to like the numbers with the Dow up about 65 points as of this writing. It decreases the likelihood of another rate hike of course and the inflation numbers were okay. My concern is that the slowdown is too much, but we'll have to see how the revisions come out in the months ahead.