Q4 GDP Surprise?

On Friday, the second round estimate of Q4 2008 GDP was released. Originally, the real growth rate for Q4 was -3.8%. But, as I noted in class, that release only approximated inventories, exports, and imports.

The value for Friday's release was fairly close to my expectation. My prediction was for a downward revision to -5.5%, but I didn't rule out a drop of around 6%. That's what we got: -6.2%. The media tried to play this as a huge surprise, but many economists saw this coming. Markets gyrated throughout the day. The Dow-Jones average started the day down over 100 points, eventually moved into positive territory, then closed down 119. ALWAYS PAY ATTENTION TO THE WEEKLY CLOSE. The ten-year bond rate closed above 3 percent, which will likely remain in force as budget deficit projections continue to rise.

The major revisions contained in the revised GDP data were a worse-than-expected fall in exports and a sharp downward reduction in inventories. Read this article about the report. Actually, the fact that inventories are much smaller than first estimated is a very positive sign. Inventories are a leading economic indicator - their behavior today signals likely changes in economic activity 3 to 6 months in the future. So, with the new inventory estimate, businesses have far less inventory to work off in future months, meaning they have already begun to work through this problem (review the Quantity Adjustment Mechanism from Supply and Demand notes). Unfortunately, working down inventories will continue for much of this year, as national and global weakness persists.

On Friday, the Dow-Jones average closed near the low of the day, which moved us very close to the 7,000 level. Next Friday the February employment data will be released. That could move us below 7,000, but only if there were very big surprises (a nightmare decline in employment, and a sharp rise in the unemployment rate). I'm not sure we'll see that as the markets have already priced in very bad employment data, especially in light of Thursday's initial claims level.