The Economy's Upside Surprise

For the U.S. economy, the surprises keep coming. One day after the release of a report that showed an unexpected surge in orders for durable manufactured goods in July , another government report showed a much larger-than-expected jump in second-quarter gross domestic product. But economists aren't ready to start uncorking the champagne just yet: Another report released on Aug. 28 showed that first-time filings for unemployment insurance fell in the week ended Aug. 23—but remain at levels consistent with a weakening labor market.

U.S. real (inflation-adjusted) GDP growth was revised upward, to a 3.3% annual rate, in the second quarter, from the 1.9% preliminary figure released in July. The market had expected a revision to 2.7%. Net exports added a staggering $85.4 billion to growth in the second quarter (or 3.1%), compared with $66.8 billion (2.4%) in the first. The revision to inventories shows them subtracting $39.2 billion from GDP, vs. the $52 billion figure reported previously.

Real spending was boosted to a 1.7% clip from 1.5% previously. Gross private investment was revised to -12.0% from -14.8%.

Housing Still in the Basement
Second-quarter government spending was revised up to a solid 3.9% growth clip, vs. 3.4% previously, while equipment and software spending contracted at a 3.2% rate. There was a surprisingly robust 13.7% growth pace for nonresidential construction. Residential construction continued its downward spiral, though at a diminished rate of 15.7% following quarterly rates of decline of 20%-27% in each of the prior three quarters.

Meanwhile, the chain price index, the GDP report's inflation gauge, was revised up to a 1.2% clip, vs. 1.1% previously. Excluding food and energy prices, the index was steady at 2.1%.

"The growth data are even better than many expected and again counter beliefs the economy was in recession in the first half of the year," wrote Action Economics analysts in an Aug. 28 Web site posting. Action left its forecast for third-quarter GDP growth of 2.0% unchanged.

"[T]he momentum going into the third quarter is clearly greater and could result in a significant upward revision to 2008 real growth estimates," says Standard & Poor's senior economist Beth Ann Bovino.

Worries Linger
But some economists were less sanguine. "[W]e think it is too soon to turn optimistic as the economy faces important challenges in the months ahead. Most important, weak consumer fundamentals will likely begin to assert themselves in the second half of the year as the stimulus from the income tax rebates begins to fade," wrote Lehman Brothers (LEH) economist Zach Pandl in an Aug. 28 note.

John Ryding, an economist for RDQ Economics, wrote in an Aug. 28 note that "the income side of the economy has expanded by only 0.3% over the last year in real terms, while expenditure-based real GDP is up 2.2%. Moreover, the income estimate of GDP fell in both the fourth quarter of last year and the first quarter of this year—looking much more like a classic recession that we think began in December 2007."

The higher-than-expected GDP figure was tempered somewhat by the initial claims data. Initial claims for unemployment insurance dropped 10,000 in the week ended Aug. 23, to 425,000. The drop was in line with market expectations of 430,000, as claims were expected to decline after spiking in the wake of the extension of unemployment benefits. Still, the weekly figure has remained above 400,000, suggesting continued labor market weakness.

"It may be the still-lofty level of claims as we approach the end of August that should be of greater concern to the markets, given the risks to the economy from an elevated price level that may still be rippling through consumers' spending decisions and business fixed investment," wrote Action Economics analysts.