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Economic Forecasts

Positive Third Quarter GDP Promises More Improvement

Odds are the economic momentum of the third quarter will continue through year-end and into early 2010. A close look at the recent government report on third quarter gross domestic product reveals some promising details.

Most importantly, consumers are returning to the market. Their spending increased 3.4% last quarter, following a second quarter decline of 0.9%. The upward blip in Aug. and sharp pullback in Sept. -- the product of the government’s “cash for clunkers” program -- obscures an important underlying trend: Consumers boosted their spending on a range of goods, not just cars, over the course of the summer. Purchases of nondurable goods, for instance, rose 2% after dropping nearly that much in the second quarter.

Inventories are being rebuilt. Slashed by retailers and manufacturers as the recession deepened early this year, that process is starting to reverse, and “the inventory rebuild could be sharp,” says Joel Prakken, chairman of Macroeconomic Advisers. Inventory changes added almost one percentage point to the GDP increase in the third quarter -- a far cry from the nearly one and a half points they subtracted in the previous quarter. That’s helping lift overall factory output. In fact, even before the clunkers program geared up, automakers recognized that dealer lots were thin and had been moving to increase production.

Housing construction is on the rise, climbing a healthy 23.4% in the third quarter -- the first jump since 2005. That contributed almost a half percentage point to the overall GDP increase. Though a likely new wave of foreclosures in early 2010 will continue to pressure prices, construction of new homes seems to have turned the corner and is likely to continue upward.

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Meanwhile, federal spending -- which rose 7.9% in the third quarter as a result of the $787 billion stimulus program -- will continue to make a positive contribution. The stimulus will add about $90 billion to GDP each quarter into late next year.

Finally, exports, which soared 14.7% in the third quarter, aren’t likely to lose much luster in coming months. One benefit of the weak U.S. dollar is the allure it imparts to U.S. products and services in overseas markets.

Despite the hopeful signs, the economy remains fragile. Business investment fell 2.5% in the third quarter, dragged down by the troubled commercial real estate market. Although businesses will invest in equipment next year, they’ll shy away from new office buildings, factories and stores. That’ll hold overall investment growth to a meager 1% or so. And spending by state and local governments fell 1.1% after a second quarter gain of 3.9%. Help won’t be forthcoming from them until the second half of next year.

While the positive third quarter is heartening, the recovery is just starting. As Lyle Gramley, former Fed governor and now senior economic adviser with the Soleil Securities Group, cautions, “We can’t get a sustained recovery unless consumer spending is increasing about 2%.” We think that’ll happen next year. In comparison to this year -- a big improvement, but nothing to write home about.