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Economy in Brief

Forecast: Investment Spending on the Wane
by Tom Moeller August 7, 2006

U.S. real GDP growth of 2.5% last quarter disappointed due to subtractions from the investment side of the ledger. A 0.1 percentage point subtraction due to lower business spending on equipment & software (-1.0% AR, +6.9% y/y) was the first q/q subtraction exerted since early 2003 while a 0.4 point subtraction from residential investment (-6.3% AR, -0.2% y/y) was the third in a row.

The economy's mainstay, consumer spending, also slowed somewhat to a 2.5% growth rate in 2Q from 3.4% growth during the prior four quarters, but a recent recovery in consumer sentiment, roughly 2% growth in real disposable income, and a possible end to the hikes in interest rates combine to suggest positive growth.

It's the sizzle that has been removed from the U.S. economy's growth potential. Since late 2003, business spending on equipment & software has been adding more than 0.5 percentage to GDP growth as residential investment added about the same amount.

Unbridled expansion? Bubbles waiting to burst? Perhaps, but additions of this magnitude have been seen before in the case of housing, and actually have been quite moderate in the case of business investment.

During the last five years real housing investment grew at an annual rate of 6.2%. A comparable, and even stronger, period of growth in the 1980s indeed was followed by bust. The robust expansion during the 1990s, however, was followed merely by slower growth. As for business fixed investment, it's up only an average 3.5% during the last five years. Indeed, growth during the four quarters ending in 1Q was revised lower to 7.4% from 8.9% reported in June. While improved, that growth probably was restrained by a moderate, but continuing, expansion of business' profit margins (which also were revised down). Arguing against a pending bust is that during the period, business net cash flow surged.

It's been said that forecasting is very difficult, especially when it's about the future. And now is certainly not the time to minimize the difficulties given higher oil prices, geopolitical risks and recent increases in interest rates. The current wisdom is that U.S. economic growth will continue at roughly a 3% pace next year despite somewhat slower growth in personal consumption, a halving of the growth in business investment and a further decline in housing. An improved foreign trade account is expected to be a modest offset to these diminutions. Stay tuned.

Forecasting Professional Forecasters from the Federal Reserve Board is available here.

Chained 2000$, % AR 2Q '06 1Q '06 Y/Y 2005 2004 2003
GDP 2.5% 5.6% 3.5% 3.2% 3.9% 2.5%
  Inventory Effect 0.4% -0.0% 0.6% -0.3% 0.4% 0.0%
Final Sales 2.1% 5.6% 2.9% 3.5% 3.5% 2.5%
  Foreign Trade Effect  0.3% -0.0% -0.1% -0.1% -0.5% -0.3%
Domestic Final Demand 1.6% 5.4% 3.0% 3.6% 4.0% 2.8%
Chained GDP Price Index 3.3% 3.3% 3.3% 3.0% 2.8% 2.1%
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