If Yellen is bullish on economy, this may be why

U.S. Federal Reserve Board Chairwoman Janet Yellen
Win McNamee | Getty Images
U.S. Federal Reserve Board Chairwoman Janet Yellen

Never underestimate the power of American consumers.

As jittery businesses and tight-fisted governments cut spending this spring, American consumers went shopping. That helped keep the U.S. economy moving ahead, but just barely.

In a closely watched speech Friday, Fed Chair Janet Yellen offered a fairly upbeat assessment of the latest data and other recent reports, pointing to the strength in consumer spending despite the overall weakness in GDP. She also noted that the job market continues to improve.

"In light of the continued solid performance of the labor market and our outlook for economic activity and inflation, I believe the case for an increase in the federal funds rate has strengthened in recent months," Yellen said.

The government's latest read on the gross domestic product pegged the second-quarter advance at just 1.1 percent, a bit slower than the original estimate reported last month.

Most of the weakness is coming from big cuts in spending and investment by businesses — down 9.7 percent in the second quarter. That belt-tightening by businesses on investment in new equipment and buildings could be a sign of a deeper slowdown ahead, according to economists at Credit Suisse.

"Extended periods of falling real business investment are strongly associated with U.S. recessions," they wrote in a note to clients. "That's why the recent three consecutive quarters of contraction are concerning."

Some of the slowdown may be tied to general uncertainty about the election cycle, which has prompted many businesses to take a wait-and-see attitude before committing dollars to new equipment or breaking ground on new buildings.

In June, a survey of business economists found that some 60 percent said that uncertainty about the November vote is damaging prospects for growth this year.

The latest data also showed that after-tax corporate profits fell at a 2.4 percent rate last quarter after rising an 8.1 percent pace in the first quarter. Weaker profits could make it harder for businesses to limit an anticipated rebound in business spending.

Businesses have also been slashing inventories, which dropped by $12.4 billion in the second quarter. The drop in inventories lopped 1.3 percent from GDP growth, the biggest drag in more than two years. It was the fifth straight quarter that inventories weighed on output.

Tight inventories could be another sign that businesses are worried about their sales prospects later this year. Some economists, though, attribute some of the drop to the second-quarter surge in consumer spending.

And consumers were clearly in a spending mood. Consumer spending jumped at a 4.4 percent annual rate, the biggest bump since the fourth quarter of 2014. That category represents some two-thirds of overall GDP.

The surge in consumer spending didn't escape notice from the Federal Reserve, which is keeping a close eye on the latest data as it mulls whether to raise interest rates in its policy meeting next month.

Despite Yellen's remarks, given the continued weak GDP data, some Fed watchers think the central bankers may hold off on a rate hike until the economy shows signs of picking up speed again.

Moody's Analytics economist Ryan Sweet still pegs the odds of a rate hike at 30 percent next month, rising to 55 percent in December.

"We believe the core of the FOMC is comfortable sitting tight, but some hawkish regional Fed presidents are getting restless," he said in a note Friday.

Though companies added nearly 200,000 jobs a month in the second quarter, some industries are hiring faster than others. And over the longer term, the recovery is playing out unevenly across the economy.

Thanks to a rebound in the housing market, the construction industry has enjoyed strong gains, with overall output up 29 percent over the last three years, based on the latest GDP numbers. Other big gainers include hospitality and health-care companies.

The biggest industry slump has come from the mining sector, where the plunge in oil prices has produced a 50 percent contraction over the last three years, forcing sharp cutbacks in hiring.