Orlando's Outlook: Solid second-quarter GDP keeps Fed on pace

07-28-2017

Bottom line The Department of Commerce this morning flashed a GDP gain of 2.6% in the second quarter of 2017, more than double a downwardly revised increase of only 1.2% in the first quarter, due to solid improvement in consumer, business and defense spending and positive net trade. Housing and inventories were a drag on second-quarter growth.

The Bloomberg consensus was expecting a 2.7% gain for the second quarter, the Blue Chip consensus estimate was at 2.8% and we had a 2.9% estimate here at Federated. The Atlanta Fed’s widely followed GDPNow estimate, by comparison, has been whipping us around for the past three months, starting at 4.3% in early May, plunging to 2.4% in mid-July and finally rising back up to 2.8% just yesterday.

Commerce also issued its annual benchmark revisions today, dating back to the first quarter of 2014. It revised lower its GDP estimates for six of the previous seven quarters. We believe these lower benchmark revisions contributed to the slight miss in this morning’s report from consensus. But we do not think there was anything here that would discourage the Federal Reserve from executing its plans to begin shrinking its $4.5 trillion balance sheet in September and hiking interest rates a third time this year in December.

GDP revisions The following table reflects today’s benchmark revisions from Commerce from 2014 through today’s second-quarter flash:

QuarterPrevious GDPNewly Revised GDP

Change

1Q14 (1.2%) (0.9%) 0.3%
2Q14 4.0% 4.6% 0.6%
3Q14 5.0% 5.2% 0.2%
4Q14 2.3% 2.0% (0.3%)
Full Year 2014 2.4% 2.6% 0.2%
       
1Q15 2.0% 3.2% 1.2%
2Q15 2.6% 2.7% 0.1%
3Q15 2.0% 1.6% (0.4%)
4Q15 0.9% 0.5% (0.4%)
Full Year 2015 2.6% 2.9% 0.3%
       
1Q16 0.8% 0.6% (0.2%)
2Q16 1.4% 2.2% 0.8%
3Q16 3.5% 2.8% (0.7%)
4Q16 2.1% 1.8% (0.3%)
Full Year 2016 1.6% 1.5% (0.1%)
       
1Q17 1.4% 1.2% (0.2%)
2Q17 ---- 2.6% ----

 

Here are the key details regarding today’s second-quarter GDP flash report:

Consumer spending rises Personal consumption expenditures, which account for 70% of GDP, rose an in-line 2.8% in the second quarter. That represents a solid recovery from an upwardly revised increase of 1.9% in the first quarter (originally reported as a paltry 1.1% gain), and roughly equals a downwardly revised 2.9% fourth-quarter gain. Today’s gain added 1.23 percentage points to overall second-quarter GDP growth. We had expected a consumer-driven rebound in second-quarter GDP, and we believe this positive trend will continue in the second half of 2017, with the potential for strong back-to-school and Christmas spending.

Housing plateaus In the most disappointing aspect of today’s GDP report, residential investment plunged 6.8% in the second quarter compared with an 11.1% surge in the first quarter, subtracting 0.27 percentage points from GDP growth, the sector’s biggest decline since 2010. Housing’s first-quarter contribution to GDP, by comparison, was a healthy addition of 0.41 percentage points. This sector had risen by 7.1% in the fourth quarter. It appeared to us that housing trends may have at least temporarily plateaued in March, as homebuilders are dealing with a shortage of both available land on which to build new homes and skilled labor. Also, relatively warm winter weather may have pulled some spring building activity forward into the first quarter.

Inventory liquidation The new inventory-restocking cycle that commenced last year and slowed in the first quarter of 2017 turned modestly negative in the second quarter, with inventories slipping $0.3 billion, which subtracted 0.02 percentage points from GDP growth. Businesses had added only $1.2 billion to inventories in the first quarter, but they had increased inventories by a robust $63.1 billion in the fourth quarter of 2016. We believe that the ongoing legislative chaos in Washington has resulted in a temporary economic chilling effect that has descended upon businesses and consumers who are reluctant to spend and invest until they see what new fiscal policies will be enacted (if any) and when.

Net trade positive The trade deficit shrunk in the second quarter of 2017, adding 0.18 percentage points to GDP, as exports rose faster than imports. Exports rose 4.1% in the second quarter, compared with a 7.3% increase in the first quarter, adding 0.48 percentage points to GDP, as the dollar was weaker during the period. Imports rose 2.1% in the second quarter, subtracting 0.31 percentage points from GDP, versus a 4.3% first-quarter increase.

Government spending gains Total government spending, which accounts for about 17% of total GDP, rose 0.7% in the second quarter, which added 0.12 percentage points to GDP, compared with a 0.6% first-quarter decline. Federal government spending rose in the second quarter, buoyed by a 5.2% increase in national defense spending that added 0.20 percentage points to economic growth. State and local spending collectively fell 0.2%.

Corporate capex increases Nonresidential real business fixed investment rose 5.2% in the second quarter, the fifth consecutive quarterly increase, adding 0.64 percentage points to GDP. That compares with gains of 7.2% in the first quarter, 0.2% in the fourth quarter of 2016 and 3.4% in the third quarter. Looking at the key components, business equipment and software rose for the third consecutive quarter (after four straight down quarters), gaining 8.2% in the second quarter of 2017, which added 0.44 percentage points to GDP. That compares with gains of 4.4% in the first quarter and 1.8% in the fourth quarter. Moreover, business structure investment—a very volatile category that includes factories and office buildings—increased 4.9% in the second quarter, consolidating the robust 14.8% gain in the first quarter, adding 0.14 percentage points to GDP. Finally, intellectual property spending rose a modest 1.4% in the second quarter, versus a stronger 5.7% first-quarter gain, which added 0.06 percentage points to GDP. We continue to believe that corporate investment spending will accelerate when President Trump’s business-friendly fiscal policies are eventually passed into law.

Connect with Phil Orlando on LinkedIn