Since 1995, first quarter GDP growth has averaged 1.3%, and, on average, is the quarter with the slowest growth; it has been worst performing quarter of the year in 11 years, more than half the time. Again, if seasonal adjustment was working, this should not be the case over a 20-year period; quarterly variations should be more randomly distributed throughout the year. Over that same time, GDP growth in second quarters has averaged 3.3%, a full 2 percentage points higher than growth in first quarters. In 14 of the past 20 years (70% of the time), GDP growth in the second quarter has been faster than in the first.
Over the past 10 years, this GDP gap has widened even more. Reported GDP growth in the first quarter between 2007 and 2016 has been -0.3%. Although this figure is clearly skewed lower by the 5.4% drop in real GDP in the first quarter of 2009, it is well below the average gain in second quarters over this period (2.4%); also, the 2.7% gap between growth in the first and second quarter is nearly seven times as wide as it was between 1950 and 1995. GDP growth in the first quarter has been the slowest quarter of growth in 6 of the past 10 years, again, not what you would expect if the seasonal adjustment process was working.
Academics and government statisticians have written many papers on why this is happening, but we’d do them a disservice by trying to recap them here. A year ago, in May 2015, the BEA acknowledged this gap, calling it “residual seasonality” and said it would attempt to adjust for it in the future; although more than a year later, the “gap” between first quarter and second quarter GDP still exists.
What Does The seasonal GDP Gap Mean For The Fed?
Why do markets care about this quirk? The market and Federal Reserve (Fed) policymakers are well aware of the first quarter GDP gap and will likely look at average GDP growth in the first and second quarter to get a better gauge of the economy. The GDP data for the second quarter of 2016 are not due out until July 29, so Fed policymakers won’t have that data in hand when they meet on June 14–15 or July 26–27. If second quarter GDP accelerates to 3%, GDP growth in the second quarter would be faster than the first for the seventh time in the past 11 years.
In addition, should it land at around 2% for the first half of the year (first and second quarters), real GDP would be growing faster than potential GDP, taking up slack and slowly pushing up wages/inflation. (See our Weekly Economic Commentary, “Building Blocks.”) Potential GDP is the “maximum” growth rate for an economy, based on labor force growth and productivity, and due to stagnant productivity and slow growth in the labor force, potential GDP is running at just under 2.0%. Even with the economy growing at around 2.0%, the Fed is already on pace to do two interest rate hikes this year. If growth accelerates into the 2.5–3.0% range in the second half of 2016, the Fed could be considering a third rate hike later this year.
John Canally is chief economic strategist for LPL Financial.