GDP rose 3 percent in the third quarter as domestic sectors showed some evidence of temporary moderation due to storms, but the economy is expected to sustain solid real growth in the fourth quarter and for 2018.
Domestic Spending: Slower Now, Longer-term Perspective
In the third quarter, spending by the consumer and business slowed as real final sales (top graph) came in at 2.3 percent compared to a gain of 2.9 percent in the second quarter and 1.9 percent for 2016. Government was a small drag on growth. In perspective, real GDP growth has averaged 2.7 percent since 1982, although the pace of growth in the current expansion is only 1.7 percent, down from 2.6 percent in the prior expansion. Going forward for real GDP, we expect a gain of 2.6 percent in the fourth quarter and 2.4 percent for 2018.
Consumer spending grew at 2.4 percent in the third quarter (3.3 percent in Q2) with gains in durables but slower in non-durables and services relative to their Q2 pace. This moderation is consistent with the slower pace of real disposable income and a modest hurricane effect. For investment, equipment was solid but structures fell while another real hit came in for residential investment (hurricane impact in TX and FL), which fell for the second quarter in a row. For the government sector, the real story is a second quarter of decline in state & local spending. So far this year, spending by state and local governments has been relatively flat.
Trade and Inventories: A Partial Score
Trade and inventory numbers provide a significant measure of volatility in initial and revised GDP estimates. The initial estimate for trade is that net exports will add 0.4 percent to GDP growth, with exports up 2.3 percent with gains in both merchandise and service exports, while imports fell 0.8 percent.
During Q3 inventories added 0.7 percent and this was a part of our forecast miss. For the second half of 2017, we anticipate a gradual reversion to the average gain in inventories for this expansion, in line with gains in final sales for both farm and non-farm inventories. This outlook is corroborated by the gains in the PMIs indices for inventory building. Inventory investment can be quite volatile over the business cycle (middle graph). In the current cycle inventory investment downshifted sharply in 2016/2017 compared to 2013-2015.
Prices: Sideways – Evidence for Caution in Policy for Investors
Overall GDP prices came in at 2.2 percent in the Q3, with the PCE deflator coming in at 1.5 percent, below the FOMC’s 2 percent target.
Inflation, as measured by the PCE deflator, is not mean reverting, in fact, the pace of inflation has trended down since 1982. The PCE deflator has averaged 2.4 percent since 1982, 1.8 percent since 1994 (NAFTA) and 1.5 percent in the current recovery.
This pace of GDP growth would bring forth an FOMC increase in the fed funds rate in December and again one move in the first half of 2018 as well as a modest rise in the benchmark two and ten year Treasury rates.
