Monday, 11 of December of 2017

Economics. Explained.  

GDP Forecasts

November 29, 2017

The first revision to third quarter GDP growth came in at 3.3% compared to an initial reading of 3.0%.  The economy grew at a 3.3% pace in that quarter despite the negative impact from Hurricanes Harvey and Irma which reduced activity in August and September.

Consumer spending climbed at a solid 2.3% pace in the third quarter but that growth rate was probably reduced somewhat by the hurricanes.  We expect consumer spending to rebound to a 4.0% pace in the fourth quarter. The prospect of tax cuts later this year has lifted 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 are expected to remain at their current relatively low level through the end of next year.  Interest rates remain low and are rising very slowly.

Investment spending rose 4.7% in the third quarter following growth of 7.2% in the first quarter and 6.7% in the second quarter.  But it was essentially unchanged for the previous 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% or so in the years ahead.

And the trade gap narrowed by $19.2 billion in the third quarter to $594.4 and thereby added 0.5% to GDP growth in that quarter.  Early in the year the dollar was strong which suggested slower growth in exports and faster growth in imports and that trade might subtract something from GDP growth in 2017.  But in the past six months the dollar has weakened significantly.  On balance, trade will  add about 0.2% to  GDP growth in 2017.

Expect GDP growth of 2.9% in the fourth quarter and growth of 2.8% or so in the first quarter of next year.  That implies GDP growth for 2017 of 2.6% and we expect 2.9% 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 inflation rate for the past couple of quarters.  However, 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.   As a result we expect the core CPI to rise  1.8% this year and 2.3% in 2018 (versus 1.7% currently).  Slightly faster inflation will push long-term interest rates higher with the 10-year hitting 2.8% by the end of 2018 and mortgage rates climbing to 4.4%.

With GDP likely to expand in 2018 at a rate slightly faster than its  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 2017 which would put the funds rate at 1.25% by the end of this year.  The Fed also began to run off some of its security holdings in early October.

Stephen Slifer


Charleston, SC


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