After a free-fall of output in the last quarter of 2008
and the first quarter of 2009, second derivatives of U.S. economic activity
have turned positive between Q2 and Q3 of 2009. That was a clear indication of
a significant slowdown in the pace of contraction and the first step toward
positive growth (and therefore positive first derivatives of economic activity,
which in the end are what really matter). An aggressive and coordinated policy
response put a floor to the free fall of output and pulled the global economy
back to positive growth.

As reported in our latest RGE
Global Economic Outlook (Q4 and Beyond – available here for paid clients),
RGE expects a strong second half of the year in 2009. We forecasted real U.S.
economic growth to come in at 3% in Q3 2009.  We expect growth to be a bit
weaker in the fourth quarter, at 2.5%.

Today’s GDP report surprised on the upside, revealing a
3.5% growth rate after consensus forecasted a 3.2% rate; yesterday, Goldman
Sachs cut their estimates ahead of the report from 3.0% to 2.7% in wake of a
lower-than-expected durable goods report.

Even if the report displayed growth just slightly above
expectations, markets rallied. Both the DJIA and S&P 500 closed the day up
over 200 points.  It is a bit puzzling why markets went up when the report
was almost in line with what was expected by consensus. Market psychology
is complicated, but could this be more of a sign of high uncertainty? It almost
feels like the markets took a deep breath.

Some Details of the Report

Inventories contributed to 1% of this strong performance.
This is smaller than anticipated and might slow down significantly when private
demand shrugs off the support coming from policy measures. The only real
quasi-surprise came from residential investments, which snapped back and
displayed a 23% annualized growth rate in the quarter (after contracting at an
average annual rate of 20% since 2006). This rebound accounts for the 0.5%
difference between our prediction and the actual reported growth. This is not
entirely a surprise. The policy incentives set in place to revive the
housing sector have produced positive effects; homebuilding activity, as a
consequence, has stabilized. Yet housing starts are still moving sideways, shy
of the 600,000 per year mark (but above the 480,000 bottom of April 2009), and
completions are still falling. This implies that a portion of the residential
investment improvement was due to spending related to home improvement, which
is perhaps the only surprise here. So, we are back to the U.S. consumer.

The full piece is available only to RGE paid subscribers
and is available
here. It includes an analysis on the outlook for the U.S. consumer and
overall economic performance.