Originally published on October 29
In this report, I identify four enduring macro themes that this morning’s data can help us update. Much of this will be familiar to you if you have been reading my work, but there are a couple aspects that are novel. Generally, the themes fit into the Saggy V hypothesis that I have been pushing, while recognizing that the lift-off phase has extended a bit further than I originally expected:
- The traditionally most cyclical components of aggregate have staged a very strong recovery recently, both outright and as a share of GDP. Normally this would imply downside risk to the economy, but in the current unusual set-up, it more likely suggests a marked slowing of growth, rather than a renewed dip into recession.
- Inventory investment is a cyclical component, although I treat it separately because its cyclicality is a bit higher frequency. The current flow of inventory investment remains modestly below normal, which means there is more likely a modest inventory impetus than headwind in store for the economy over the next few quarters. However, Q3 was a massive outlier, as the swing of inventory investment alone delivered 6 ½ percentage points to the overall GDP growth rate, a 70 year record. That is a major reason the ISM spiked. And the completion of the impetus is a major reason the ISM has fallen. Separately, do not react to the inventory/sales ratio. As a timing indicator, it is useless.
- The strength in the cyclical components of demand relate closely to the strong recovery of the goods and structures side of the economy. This is not unusual in a cyclical upswing. But what is unusual is that the service sector bore the brunt of the decline and is still very weak in level terms. This should contribute to a weaker growth rate but also lower economic volatility going forward.
- Within the tangible side of the economy, business investment in equipment and structures has been relatively muted, compared to the stronger recovery in household sector spending. And structures investment has been weaker than equipment. The latter fits the idea of the Covid as a reallocation as well as aggregate demand shock. And the former fits into the slow growth but not double dip central case, in part because capital stock rates are low, implying no contractionary overhang.