Monday, 24 of September of 2018

Economics. Explained.  

GDP, Inflation, and Interest Rate Forecasts

September 14, 2018

The first revision to second quarter GDP growth came in at 4.2% compared to an initial reading of 4.1%.  First quarter growth was 2.2%.

Hurricane Florence will probably trim third quarter growth by about 0.2%.  But whatever growth is lost in Q3 will be recaptured in Q4.  Accordingly, we now expect 2.9% GDP growth in the third quarter followed by 3.2% growth in the fourth quarter.  Growth for the year remains at 3.1%.

Consumer spending rose 3.8% after having risen 0.5% in the first quarter and we expect it to rise 2.5% in 2018.  The consumer and corporate tax cuts should lift the stock market to yet another record high level by yearend.  The increase in stock prices and rising home prices are 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 are expected to decline somewhat as the year progresses.  Interest rates remain low and are rising very slowly.

Investment spending climbed 8.5% in the second quarter after having jumped 11.5% in the first quarter.  However, investment spending was essentially unchanged for 2014-2016.  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% or so in the years ahead.

The trade gap narrowed by $58.7 billion in the second quarter after having widened by $3.1 billion in the first quarter.  This means that the trade component added 1.4% to GDP growth in the second quarter.  We expect the trade component to add 0.4% to GDP growth in 2018.

Nonfarm inventories declined $27.9 billion in the second quarter and subtracted 1.1% from GDP growth in that quarter.  Inventories never decline by that magnitude.  Inventory restocking in the final two quarters of the year should boost GDP growth by as much in the second half of the year as they subtracted in Q2.

Expect GDP growth of 3.1% in 2018 after having registered growth of 2.5% in 2017 as investment spending surges.  We then expect it to climb by 2.9% in 2019.

The inflation rate is gradually beginning to climb.  The economy is at full employment which finally appears to be boosting wages.  Both manufacturing and non-manufacturing firms are paying high prices for their raw materials so commodity prices are on the rise.  There is a shortage of available homes and apartments in the housing sector which is raising rents.  Thus inflation does, in fact, seem headed higher as the year progresses.   However, the pickup in inflation will be limited as internet price shopping will keep goods prices falling in 2018.  As a result we expect the core CPI to climb from  1.8% last year to 2.4% in 2018.  The overall CPI should also increase 2.4% this year.

Slightly faster inflation will push long-term interest rates higher with the 10-year hitting 3.2% by the end of 2018 and 3.9% in 2019.  Mortgage rates should climb to 4.8% by the end of this year and 5.5% by the end of 2019.

With GDP likely to expand in 2018 at a rate slightly faster than its current potential and inflation expected to rise 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 two more rate hikes in 2018 which would put the funds rate at 2.3% by the end of the year.  It should rise further to the 3.2% mark by the end of 2019.  The Fed will also continue to run off some of its security holdings throughout 2018 and 2019.

Stephen Slifer

NumberNomics

Charleston, SC

 


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