Saturday, 19 of August of 2017

Economics. Explained.  

GDP Forecasts

July 28, 2017

Second quarter GDP growth came in at 2.6% which was roughly in line with expectations.  That confirms that the first quarter growth rate of 1.2% was an anomaly.  Second, the variious categories suggest that GDP growth will remain strong for the foreseeable future.

Consumer spending rose a solid 2.8% in the second quarter.  It is hard to see it slowing down any time soon.    The prospect of tax cuts later this year is boosting the stock market to a record high level.  The increase in stock prices is boosting household wealth.  The gains in employment are generating income which gives consumers the ability to spend.  Consumer debt is very low in relation to income.  Consumer confidence is at a multi-year high.  Gas prices remain low  Interest rates remain low and are rising very slowly.

Investment spending rose 7.0% in the first quarter and an additional 5.1% in the second quarter.  But it was essentially unchanged for the past three years.  It appears that the prospect of corporate tax cuts, repatriation of earnings at a favorable tax rate, and a reduction in the regulatory burden is giving business leaders confidence to open their wallets and spend on new equipment and technology.  Not only will this boost GDP growth in the short term, if investment continues to climb it will boost productivity growth which will, in turn, raise the economic speed limit from about 1.8% today to 2.8%.

And the trade component should be about unchanged this year.  Early in the year the dollar was strong which suggested slower growth in exports and faster growth in imports.  As a result, trade seemed likely to subtract a bit from GDP growth this year.  But in the past six months the dollar has weakened and now trade appears to be a roughly neutral factor in 2017.

Expect GDP growth of 3.0% and 2.5% in the final two quarters of the year.  That implies GDP growth for 2017 of 2.3% and we expect 2.8% growth in 2018.

The recent price war amongst wireless phone providers and falling prescription drug prices caused by Trump-led intimidation of the industry has slightly lowered the trajectory for inflation.  However, the economy is at full employment and there is a shortage of available homes and apartments in the housing sector so inflation does, in fact, seem headed higher as the year progresses.   As a result we expect the core CPI to rise  1.9% this year and 2.5% in 2018 (versus 1.7% currently).  Slightly faster inflation will push long-term interest rates higher with the 10-year hitting 2.42% by the end of 2017 and mortgage rates climbing to 4.2%.

With GDP expanding at a pace at roughly its potential and inflation only slightly above its target, the Fed will feel compelled to continue on a path towards gradually higher interest rates.  It needs to do so to get itself into position to lower rates when the time comes, but it appears to have the luxury of taking its time.  We expect one more rate hike in 2017 which would put the funds rate at 1.25% by the end of this year.  We also expect the Fed to begin running off some of its security holdings prior to yearend.

Stephen Slifer

NumberNomics

Charleston, SC

 


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