A post in October 2015 argued that US economic growth would undershoot consensus expectations because 1) narrow money trends, which lead activity by six to 12 months, had weakened sharply and 2) the level and rate of change of inventories were elevated relative to sales / output, suggesting that the three to five year Kitchin stockbuilding cycle was about to turn down (having last bottomed in 2012).

These reasons for pessimism have now reversed. Six-month growth of real narrow money, defined as currency in circulation plus demand deposits divided by consumer prices, has risen from a low of 0.2% (not annualised) in October 2015 to 4.4% in June.

The rate of change of inventories, meanwhile, turned negative in the second quarter, a drawdown having last occurred in the third quarter of 2011. It would be premature to declare the Kitchin downswing over, since the level of stocks remains elevated relative to sales – see first chart. The large GDP growth drag from inventories during the first half, however, is unlikely to be repeated.


A further reason for optimism is an improving profits backdrop. Last week’s GDP release contained a significant upward revision to the level of profits in recent quarters, along with a stronger rebound in the first quarter. A second-quarter number is not yet available but a further increase is implied by faster growth of nominal GDP (3.5% annualised) than employee compensation (2.6%) – second chart. Together with lower corporate financing costs, this may contribute to a rebound in business investment.


What are the risks? One is that slow first-half growth feeds through to weaker near-term employment gains, undermining consumer spending, which has been a recent bright spot. July consumer surveys, however, do not suggest much pull-back: the expectations component of the Conference Board confidence measure, for example, remains consistent with solid spending expansion – third chart.


A second risk is that wages continue to pick up in response to a tight labour market, aborting the recent profits recovery. Annual growth in the wages and salaries component of the employment cost index rose to 2.5% in the first quarter, equalling a high reached in the first quarter of 2015. The latter was boosted by unusually large bonus / incentive payments: excluding incentive-paid occupations, wage growth is on a strong upward trend – fourth chart.


A probable rebound in GDP growth coupled with rising wage pressures argues for a central scenario in which the Federal Open Market Committee raises the target funds rate during the second half, with a September move still possible.