It now looks like that, instead of the 3.3% real GDP growth 2014 that we expected at the end of last fall, we are going to have half that: a 1.7% real GDP growth 2014. But the having of growth is coming 100% out of productivity: all labor market indicators are on the track that was expected late last fall.
Trying to wrap my head around this turning out to be really, really difficult.
The undershoot relative to previous expectations of first-quarter real GDP growth by 6%-points, followed by no bounce-back catch-up at all, would seem to be bad news for inflation, for profit margins and hence stock valuations, and for long-run potential GDP. But the stock market does not seem to care. And inflation expectations as measured by the TIPS-Treasuries breakeven do not seem to care.
Is it that people trading in the breakeven think that the Federal Reserve will hit the economy on the head if inflation starts to rise, and so think that the stock market in failing to react and fall is irrational? Is it that people trading in the stock market think that the effect of lower long-run potential and lower profit margins on real stock values are offset by higher inflation and hence have no impact on nominal stock market values, and that the breakeven market by failing to markup future inflation is irrational? If you think the markets had it right in January, then right now either the stock market is too high or the TIPS-Treasuries interest-rate spread is too low. People ought to have been shorting the stock market, shorting treasuries, and hedging by buying TIPS on a large scale.
The stock market should have fallen, TIPS should have risen (in price), or Treasuries should have fallen (in price) as it became clear first set the first quarter of 2014 would be so bad and then that there would be no bounce back in real GDP.
I find the failure of any of these three things to happen disturbing. It suggests a lack of faith by Ms Market in the national income identities...