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The nation's economy, which is represented by its gross domestic product (GDP), had been expected to moderate notably in the fourth quarter from the artificially high third-quarter growth rate of 3.1%, did even worse than forecast, actually declining by 0.1%. That nominal shrinkage, the first such setback in three and a half years, was basically driven by declines in government spending--most specifically defense outlays--as well as lower exports and a slowdown in inventory growth.

That weaker-than-expected performance--expectations had been that growth would have approximated 1%--while driven largely by the one-time events cited above, was disquieting, nonetheless. Indeed, the surprise contraction raised some fears about the economy's ability to handle the large payroll tax increase put upon all wage earners this month. Here, payroll tax deduction, for social security payments, went from the 4.2% rate of the past two years, to the 6.2% rate in place before that time. The adjustment for the self-employed was even steeper.

Meanwhile, the major impediments to growth in the quarter, most notably the biggest cut in defense spending in 40 years, offset faster growth in consumer spending, business investment, and housing. It was these latter increases, in three critical categories, that should encourage economists going forward.

As to what this report suggests about the economy is that we probably will see a resumption of growth as early as the current quarter. However, the expected pace of that improvement will likely be small given the need to initially adjust to the higher social security taxes being withheld.

Meantime, the days to come will see other critical economic issuances, starting this afternoon with the results of the two-day Federal Reserve FOMC meeting, where no change in the current easy monetary course is expected. Then, on Friday, the government will issue its monthly report on non-farm payrolls and the unemployment rate. Here, payroll growth in excess of 150,000 is forecast along with an unchanged 7.8% rate of joblessness. Also, on Friday, the Institute for Supply Management, an Arizona-based trade group, will issue its latest survey on manufacturing activity across the country.

All told, we suspect that growth in the current quarter will approximate, or perhaps exceed, 1%, the likely weakest growth rate this year, and a forerunner to what we believe will be a roughly 2% growth rate for the year as a whole. 

At the time of this article’s writing, the author did not have positions in any of the companies mentioned.