Thursday, 15 of November of 2018

Economics. Explained.  

GDP, Inflation, and Interest Rate Forecasts

November 2, 2018

The first look at GDP growth in the third quarter came in at 3.5% which compares to second quarter GDP growth of 4.2%.  We expect GDP to rise 3.0% this year and 2.9% in 2019.

Consumer spending rose 4.0% in the third quarter after having risen 3.8% in the second quarter.  We expect it to rise 2.6% in 2019.  The consumer and corporate tax cuts should lift the stock market to yet another record high level by yearend.  Stock prices should rebound which will boost 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 an 18-year high.  Interest rates  are rising very slowly but remain low.

Investment spending took a breather and slowed to 0.8% in the third quarter after having climbed 8.7% in the second quarter.  Investment spending was essentially unchanged for 2014-2016.  It appears that the corporate tax cuts, repatriation of earnings at a favorable tax rate, and a reduction in the regulatory burden are 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 by the end of this decade.

The trade gap widened by $98 billion in the third quarter to -$939.0 billion after having narrowed by $61.4 billion in the second quarter.  This means that the trade component subtracted 1.7% from GDP growth in the third quarter after having added 1.4% to GDP growth in the second quarter.  We expect the trade component to have no impact on GDP growth in 2018 and subtract 0.1% from GDP growth in 2019.

Nonfarm inventories surged by $76.3 billion in the third quarter after having declined $36.8 billion in the second quarter. Going forward we expect inventories to climb by about $42 billion per quarter.

Expect GDP growth of 3.0% in 2018 and 2.9% in 2019 after having registered growth of 2.5% in 2017.

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 2.2% in 2018 and 2.4% in 2019.

Slightly faster inflation will push long-term interest rates higher with the 10-year hitting 3.3% by the end of 2018 and 4.1% in 2019.  Mortgage rates should climb to 4.9% by the end of this year and 5.7% 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 one more rate hike in 2018 which would put the funds rate at 2.2% 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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