Are We Headed for a Recession?

GDP growth 2011 2012The U.S. Department of Commerce announced on Wednesday that U.S. GDP declined 0.1% in the fourth quarter. In sharp contrast, GDP grew a little over 3% in the prior quarter.  The decline is the first drop in GDP since 2009. The drop was unexpected but the reaction from the markets was tepid. The details provided by the government showed that the decline was due mostly to cuts in government spending, particularly in defense. Consumer spending, business investment, and housing remained strong. The subdued reaction by the markets to the GDP news was due in part to the Fed’s announcement, on the same day as the government’s, that it will continue its accommodating policies into the future. The Fed will continue its $85 billion per month quantitative easing program, hold interest rates near zero, and revise its policies only when unemployment falls further.

Investors found solace in the Fed’s reaction and in the GDP numbers. The Fed also reassured investors that the decline in GDP was temporary – an aberration brought on by adverse weather, such as Sandy’s impact on the Northeast. Overall GDP growth for 2012 was 2.2%, better than the 1.8% last year. Corporate earnings remain strong as well, not showing signs of a sluggish economy. The Commerce Department’s GDP report showed that household incomes increased 6.8%, net of taxes and inflation. Inflation fears were eased by the report as well, showing that inflation was just 1.2% in the fourth quarter. Consumer spending rose 2.2% and home construction rose 15.3% – giving credence to a housing recovery in the U.S. Investors were reassured that the economy is on the right track and the current quarter was just a bump in the road.

The expiration of the payroll tax holiday and higher tax rates gave economists fear that people would spend less in 2013. Sequestration also loomed as a factor to hamper GDP growth. Economists were appeased by the accelerated dividends paid in December by companies to avoid the increased taxes in the new year. They believe the dividends will act as a sort of stimulus for 2013. The new Congress seems open to a debt limit deal as well so most economists and investors see better GDP growth for 2013. ADP also announced that private companies added 192,000 jobs in January – 7,000 more than in December. So, the slight contraction in GDP was not manifesting itself as job losses in the private sector. Also, as seen on Wednesday, economists expect the Fed to take any necessary measures in reaction to negative news on the economy. Europe also continues to mend and Asia has rebounded after worries, especially in China, about slowing economic growth have subsided with positive economic data.

Although there are headwinds going forward into 2013, most economists see the U.S. economy continuing its climb from the depths of the Great Recession. The unexpected news of a GDP contraction was assuaged by the trends in the different sectors of the economy, the Fed, and positive economic data.

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