Stronger 2Q Growth Backs Case for Fed Rate Hike

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By Krista Hughes

WASHINGTON -- The U.S. economy expanded more than previously estimated in the second quarter on stronger consumer spending and construction, backing the case for an interest rate rise before the end of the year despite data sounding a note of caution for September.

The Commerce Department said Friday gross domestic product rose at a 3.9 percent annual pace in the April-June quarter, up from the 3.7 percent pace reported last month.

The data supports the case that the U.S. economy may be gaining enough strength to withstand an increase in benchmark interest rates from record low levels despite growing concerns about the global economy.

%VIRTUAL-pullquote-There are a lot of things to like about the domestic side of the economy for the second half of the year despite all the global malaise.%Still, many economists are expecting a cooler pace of growth in the third quarter, a view bolstered by separate data showing slower growth in services and a drop in consumer sentiment in September.

The U.S. Federal Reserve last week held off on hiking rates, but Fed Chair Janet Yellen kept the door open to an increase this year in a speech on Thursday night, as long as inflation remains stable and growth is strong enough to boost employment.

"There are a lot of things to like about the domestic side of the economy for the second half of the year despite all the global malaise," said Jacob Oubina, senior economist at RBC Capital Markets in New York. "If the domestic economy holds in there, [Fed policymakers] are going to hike in December."

Second-quarter growth, which beat expectations in a Reuters poll for the third GDP reading to be unchanged at 3.7 percent, was bolstered by higher consumer spending, mainly on services like healthcare and transport.

Treasury debt prices extended losses and the dollar hit a fresh five-week high against a basket of currencies on the second-quarter figures, although U.S. stock index futures pared some gains after the September data was released.

The preliminary Purchasing Managers Index for the services sector from Markit slipped to 55.6 in September from the final 56.1 reading in August. A reading over 50 signals expansion in economic activity.

"The survey data point to sustained steady expansion of the U.S. economy at the end of the third quarter, but various warning lights are now flashing brighter, meaning growth may continue to weaken in coming months," said Chris Williamson, chief economist at Markit.

The University of Michigan's final reading on consumer sentiment for September slipped to 87.2 from 91.9 in August, although it was higher than expectations.

Stronger Base

But the stronger consumer spending and a smaller inventory build reported for the second quarter are a good sign for growth in the July-September period.

Consumer spending, which accounts for more than two thirds of U.S. economic activity, was revised up to a 3.6 percent growth pace from the 3.1 percent rate reported in August, helped by cheap gasoline prices and relatively higher house prices boosting household wealth.

Revised construction spending data helped to push up the headline figure, with non-residential fixed investment expanding 4.1 percent in the quarter. Business investment on structures was revised upwards along with residential fixed investment.

The revisions to second-quarter growth also reflected a smaller accumulation of inventories than earlier estimated, reducing the chance that a sharp unwinding in inventories would drag on growth.

"For the Fed, the forward-looking part is most important and the one positive take-away is inventory contribution," said Gennadiy Goldberg, interest rates strategist at TD Securities.

"There had been quite a bit of fear that strong inventory building in Q2 would be unwound in Q3. It actually shows GDP should be a little firmer in the next quarter, but not by a whole lot."

After-tax corporate profits were also stronger in the second quarter than previously thought. Profits after tax with inventory valuation and capital consumption adjustments showed a 2.6 percent rebound from a slump in late 2014 and early 2015.

-Richard Leong, Michael Connor and Gertrude Chavez-Dreyfuss contributed reporting from New York.

9 Numbers That'll Tell You How the Economy's Really Doing
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Stronger 2Q Growth Backs Case for Fed Rate Hike
The gross domestic product measures the level of economic activity within a country. To figure the number, the Bureau of Economic Analysis combines the total consumption of goods and services by private individuals and businesses; the total investment in capital for producing goods and services; the total amount spent and consumed by federal, state, and local government entities; and total net exports. It's important, because it serves as the primary gauge of whether the economy is growing or not. Most economists define a recession as two or more consecutive quarters of shrinking GDP.
The CPI measures current price levels for the goods and services that Americans buy. The Bureau of Labor Statistics collects price data on a basket of different items, ranging from necessities like food, clothing and housing to more discretionary expenses like eating out and entertainment. The resulting figure is then compared to those of previous months to determine the inflation rate, which is used in a variety of ways, including cost-of-living increases for Social Security and other government benefits.
The unemployment rate measures the percentage of workers within the total labor force who don't have a job, but who have looked for work in the past four weeks, and who are available to work. Those temporarily laid off from their jobs are also included as unemployed. Yet as critical as the figure is as a measure of how many people are out of work and therefore suffering financial hardship from a lack of a paycheck, one key item to note about the unemployment rate is that the number does not reflect workers who have stopped looking for work entirely. It's therefore important to look beyond the headline numbers to see whether the overall workforce is growing or shrinking.
The trade deficit measures the difference between the value of a nation's imported and exported goods. When exports exceed imports, a country runs a trade surplus. But in the U.S., imports have exceeded exports consistently for decades. The figure is important as a measure of U.S. competitiveness in the global market, as well as the nation's dependence on foreign countries.
Each month, the Bureau of Economic Analysis measures changes in the total amount of income that the U.S. population earns, as well as the total amount they spend on goods and services. But there's a reason we've combined them on one slide: In addition to being useful statistics separately for gauging Americans' earning power and spending activity, looking at those numbers in combination gives you a sense of how much people are saving for their future.
Consumers play a vital role in powering the overall economy, and so measures of how confident they are about the economy's prospects are important in predicting its future health. The Conference Board does a survey asking consumers to give their assessment of both current and future economic conditions, with questions about business and employment conditions as well as expected future family income.
The health of the housing market is closely tied to the overall direction of the broader economy. The S&P/Case-Shiller Home Price Index, named for economists Karl Case and Robert Shiller, provides a way to measure home prices, allowing comparisons not just across time but also among different markets in cities and regions of the nation. The number is important not just to home builders and home buyers, but to the millions of people with jobs related to housing and construction.
Most economic data provides a backward-looking view of what has already happened to the economy. But the Conference Board's Leading Economic Index attempts to gauge the future. To do so, the index looks at data on employment, manufacturing, home construction, consumer sentiment, and the stock and bond markets to put together a complete picture of expected economic conditions ahead.
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