US: The inventory drag is likely to persist – Deutsche Bank

Research Team at Deutsche Bank, suggests that the last week's US advance Q2 2016 GDP report indicated that the liquidation of inventories that they have been anticipating for several months has started.

Key Quotes

“Inventories declined -$8.1 billion last quarter, compared to a $40.7 billion dollar increase in Q1. As a result, inventories alone took nearly -120 bps off Q2 GDP growth.

Interestingly, de-stocking would have had an even more adverse effect on growth if estimates of inventory accumulation had not been marked down substantially in the annual revisions that accompanied the Q2 GDP release: These downward revisions tallied -$27.6 billion for Q1 2016, -$83.3 billion for the four quarters ending Q1 2016 and -$54.0 billion in aggregate across the 13 quarters covered by the revisions. Inventory accumulation has now subtracted from growth for five consecutive quarters.

We have been worried about the elevated level of inventories relative to aggregate demand because it means that future demand can be met from existing stockpiles rather than production of output. This phenomenon was evident in the Q2 GDP data: Although consumption was up a healthy 4.2% and aggregate demand (measured as GDP minus inventory accumulation for the purpose of this exercise) increased at a decent 2.4% rate, top-line GDP growth was only 1.2%.

In this regard, the downward revisions to past inventory levels are a modest positive for the outlook because they have likely reduced the extent to which inventories will weigh on output going forward. However, the slowdown in inventories has been accompanied by weakness in aggregate demand. The year-over-year growth rate of the latter has declined from a cyclical high of 3.2% as of Q3 2014 to just 1.9% in Q2 2016. As a result, the ratio of economy-wide inventories to final sales remains elevated relative to its historical trend. Since our outlook on demand is cautious, we expect further de-stocking in the next few quarters.

Even if demand were to accelerate, inventories would likely dull the positive impact of this development; if instead demand were to lose further momentum, inventories would exacerbate the slowdown. For this reason, we expect GDP growth to remain below trend in the near term.”