Good GDP, Soft Deflator

US Q4 GDP grew at an annualized pace of 3.2% in Q4, spot in line with expectations. This follows the 4.1% growth in Q3.  Still, the data is unlikely to quiet the skeptics who argue the US economy has become dependent on the yield compression of quantitative easing. 

After all this kind of growth has been seen before, only to falter.  The growth in H2 was the fastest six months since the 6-month period that ended in March 2012.  The subsequent slowdown saw Operation Twist and then QE3+.   In 2013 the US economy grew 1.9% compared with 2.85 growth in 2012. 

In Q4, the US economy was held back by the continued tightening of fiscal policy and weakness in home building.  Government spending fell at a 4.9% annualized rate, shaving almost a percentage point off growth.   Residential construction fell at nearly a 10% annualized pace; taking 0.3 percentage points off growth. 

Consumption, business investment (in equipment) and a smaller trade deficit contributed to the growth.  Household consumption rose 3.3%.  While lower than expected, it improved from the 2% pace seen in Q3.   Consumption accounted for 2.3 percentage points of growth.  Equipment purchases by businesses added 0.4 percentage points to growth.  Intellectually property, now included in GDP calculations rose at a 3.2% annualized rate. 

Inventories added less to growth than the heady pace seen in Q3.  In Q3 inventories rose by about $59 bln and in Q4 by $11.5 bln.    The trade deficit narrowed and this added 1.33 percentage points to growth, the most since Q2 2009. 

Of note the core PCE deflator slipped to 1.1% from 1.4%. The low inflation and the falling participation rate in the labor market are the two main challenges as 2014 gets under way.

The market did not appear to react much to the data.  The growth differentials are expected to lead to wider interest rate differentials and stronger dollar over the course of the year.     The US-German 2-year interest rate differential, which often tracks the euro-dollar exchange rate closely, is at six month high now, though the euro is not only at 6-day lows.    The spread between US and Japanese 10-year yields has fallen from almost 2.30% at the end of last year to 2.04% yesterday.  The yen is the strongest currency against the dollar this year, gaining about 2.6% to date.