U.S. Economic Outlook

The US economy expanded by an eye-popping 5.7% pace in Q4 09, according to the government's initial estimate, the fastest in six years. The slower pace of de stocking, contributed about 3.4 percentage points to GDP. Consumer spending rose at a 2% clip, a bit better than expected, but off the 2.8% pace seen in Q3 09 that was boosted by the cash-for-clunker program.

Another highlight was business purchases of equipment and software, which rose at a 13% annual pace in Q4, the most in three years. However, this was largely offset by a 15% drop in commercial construction. That leaves total business investment up just shy of 3%. Residential construction fared better, rising at a 5.7% annualized pace, though slower than the 19% pace in Q3. Elsewhere note that net exports added 0.5% to GDP, while government spending shaved 0.2%.

Today's data will be revised in both February and March. Areas that are the most vulnerable to revisions are the trade, capital investment and inventory data. Given the caveat about revisions, is there anything in Q4 GDP that might shed some light on the growth prospects here in Q1? There are a few points. The first obvious place to look is inventories. Remember what is important here is the change in the change. The preliminary estimate suggests that inventories fell by $33.5 bln in Q4 after a $139.2 bln liquidation in Q3 and a $160.2 bln liquidation in Q2. The $103 bln swing in Q4 is large from a historical point of view. It seems that another $100 bln improvement is unlikely in Q1 10. Second, to the extent that a new version of Windows boosted business purchases of software, this too may not have the same potency in Q1 10. With home sales losing momentum, residential construction may also not repeat Q4's performance. Net exports may swing from a small positive to a small drag. On the other hand, government spending may make a modest contribution to growth. At this juncture, we would look for Q1 GDP slow considerably to the 2.75%-3.25%.

We may not get clear confirmation that the economy is starting to moderate in next week's January ISM and employment data. Headline ISMs should point to ongoing strength in the economy and based on regional data, details may also remain firm. The consensus is looking for the ISM manufacturing index to ease only slightly from the 4-year high set in Dec09 to 55.6 from 55.9 according to a Bloomberg survey. That reading would still be above the Q4 average of 54.9. The consensus expects the ISM services index to rise to 51.0 from 50.1 which would be the highest level since May08. Regional data suggests that new orders should remain strong in Jan. The inventory component is likely to point to further de stocking although at a slower pace.

US Jan payrolls are expected to be positive for only the second time since Dec07. We see a risk that the data beat the consensus forecast for a 20K rise, rising by 25K to 50K. The hiring of workers for the 2010 census should begin kicking in at the start of 2010 and benchmark revisions, expected to be released with next week's data could see upward revisions. While weekly jobless claims deteriorated in Jan reflecting filings delayed during the holiday period, other data point to improving jobs data in Jan. Consumer confidence improved and the employment component of the regional PMI reports suggest the employment components of the ISM data could improve in Jan, a sign of strength. Still, the threshold for the payroll data is 100K. The rule of thumb suggests a 100K rise in employment is needed to stabilize the unemployment rate. The consensus expects the unemployment rate to remain elevated at an unchanged at 10.0% in Jan.