Sunday, 25 of June of 2017

Economics. Explained.  

GDP Forecasts

June 16, 2017

First quarter GDP growth was revised upwards from an initially published growth rate of 0.7% to 1.2%.   A lot of the weakness came in inventories which rose by just $4.3 billion in the first quarter compared to $49.6 billion in the first quarter.  Thus, the inventory component subtracted 1.0% from GDP growth in the first quarter.  The other source of weakness was consumption spending which rose just 0.6% — the slowest rate of growth in this category since the recession.  However, consumer fundamentals remain strong.  The gains in employment are generating income which gives consumers the ability to spend.  Consumer debt is very low in relation to income.  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.  Consumer confidence is at a multi-year high.  Gas prices remain low and are falling.  Interest rates remain low and are rising very slowly.  Consumer spending will not remain subdued for long.

We continue to expect a pickup in growth in the quarters ahead for a couple of other reasons as well.   First,  falling prices in 2014 and 2015 hit the manufacturing sector hard — the oil patch in particular — and negatively impacted GDP growth the past couple of years.  But with gasoline prices having risen, the earlier drag on GDP growth has disappeared as drillers are re-opening previously closed wells.

In addition, the 22% increase in the value of the dollar between October 2014 and the end of last year hit the trade sector hard — export firms in particular.  But the dollar has been relatively stable for the past six months so this drag on the economy has also disappeared.

Likely cuts in both individual and corporate income tax rates along with simplification of the tax codes, combined with repatriation of corporate earnings currently locked overseas and huge investments in spending on infrastructure  should help.  Expect GDP growth of 2.5% in the second quarter of this year with 2.8% and 2.7% growth in the final two quarters of the year.

Given that the economy is at full employment that faster pace of growth will probably boost the CPI  to 2.0% this year and the core CPI to 2.1%.  Higher inflation will push long-term interest rates higher with the 10-year hitting 2.65% by the end of 2017 and mortgage rates climbing to 4.4%.

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.

Stephen Slifer

NumberNomics

Charleston, SC

 


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