Steve Blitz Morning Notes

The numbers are in and, yes, the data now reflect a downturn as bad as we thought it was but the important question is what kind of economic recovery are we building. The inflation hawks should be quieted by the data revisions further widening the margin between actual and potential GDP. The second quarter data shows the usual early signs of an economy about to leave recession -- a positive push now and in the next several quarters from government spending, a smaller trade deficit, and inventory restocking. Of most interest to me, however, the contribution to growth that is going to come from business investment in capital equipment and software.

The chart below illustrates the contribution of business spending to real GDP growth. It is striking just how much of a drag business spending was during the current downturn, considering that it was never near the contributor to growth that it was during the 1990s. The current decade has, in fact, the distinction of having capital equipment spending adding the least to real GDP growth in the post-war period.

Of greater concern is the longer lag between the end of recession and the beginning of capital spending adding to GDP growth. Pre-1990 it was either on the mark with the end of recession or one quarter after. It took four quarters post the 1990-91 recession and five quarters post the 2001 downturn.

If we are going to get the more balanced, less leveraged growth in the economy going forward then the economy needs to be led by investment spending and that is only going to happen if a cheaper dollar boosts exports and import substitution. I believe the dollar will cheapen and the economy will see lots of energy-related investments (see 1970s) and investment spending will be a key contributor to growth in the recovery to come.

To get there, expect the funds rate to not rise by 200bp in the next 18 months as implied by the Treasury curve and contradicted by NY Fed President Dudley. As for inflation, considering the gap here and the over-capacity globally, by the time it is in an issue the policymakers and bond vigilantes will be focused on something else.