Orlando's Outlook: What hurricanes?

10-27-2017

Bottom line GDP grew by a much stronger-than-expected annualized pace of 3% in the third quarter of 2017, as the economy largely shrugged off the negative hit we had expected from hurricanes Harvey and Irma. Combined with the second-quarter’s 3.1% gain, this 6-month period marks the economy’s strongest growth in back-to-back quarters in three years. According to the Department of Commerce’s flash report this morning, third-quarter strength was paced by a faster-than-expected rebound in consumer spending, an accelerated pace of inventory restocking and a stronger improvement in net trade. Housing, government spending and nonresidential structures were a collective drag.

The Bloomberg consensus was a 2.6% gain for the third quarter, the Blue Chip consensus was 2.4% and ours here at Federated was 2.5%. The Atlanta Fed’s widely followed “GDPNow” estimate was 2.7%, down from 4% at the beginning of the quarter, to reflect the damage from the hurricanes.

This renewed sense of economic vigor over the past six months has largely occurred due to the resumption of animal spirits among businesses and consumers, as the prospect of structural fiscal policy reform in Washington is still at least a quarter or two away from reality. We are maintaining our above-consensus forecast for fourth-quarter GDP growth at 3% (compared with the Blue Chip’s more conservative consensus estimate only 2.6%), as the rebuilding effort from Harvey and Irma commences, in conjunction with our expectations for a solid holiday season and continued strength in manufacturing and trade. All told, today’s data probably keeps the Fed on track to hike interest rates by another quarter point at its mid-December policy-setting meeting, and the S&P 500 leaped to a new record high today.

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

Economic impact from the storms According to the Bureau of Economic Analysis (BEA), “it is not possible to estimate the overall impact of Hurricanes Harvey and Irma on 2017 third-quarter GDP.” In addition, a third hurricane (Maria) devastated Puerto Rico and the U.S. Virgin Islands. But the BEA’s GDP estimates do not include commonwealths or territories of the U.S., “so the impacts of Maria are not directly reflected in the estimate of U.S. GDP.”

BEA’s preliminary estimates show that Harvey and Irma resulted in disaster losses of $121 billion in privately owned fixed assets and $10.4 billion in government-owned fixed assets, for a total of $131.4 billion in damages. Moreover, the BEA estimates that domestic insurance companies expect to pay storm-related benefits for disaster losses of $64.7 billion; the federal government’s National Flood Insurance Program, $19 billion; Florida Citizens Property Insurance Corp., $1.2 billion; and foreign insurance companies, $17.4 billion, which totals $102.3 billion in insurance aid.

Consumer spending rebounds Personal consumption expenditures, which account for 70% of GDP, rose by a better-than-expected 2.4% in the third quarter, compared with consensus expectations for a more tepid 2.1% pace of growth. While that’s down from the second quarter’s much stronger gain of 3.3%, the recent quarter was stronger than the first quarter’s increase of 1.9%. Today’s gain added 1.62 percentage points to overall third-quarter GDP growth. Back-to-School (BTS) spending rose by a solid 3.9% year-over-year in the third quarter (paced by a very strong September coming out of the storms), marking the best BTS season in three years. This gives us some confidence that upcoming holiday spending will be comparably strong.

Inventory rebuild accelerates Inventories grew in the third quarter at their strongest pace this year, adding 0.73 percentage points to GDP growth and kicking off a new inventory-restocking cycle. Businesses had increased inventories by a robust $63.1 billion in the fourth quarter of 2016. But that pace fell off a cliff in the first quarter of 2017, as business restocking shrunk to a miniscule $1.2 billion. But they added $5.5 billion in the second quarter and a sizable $35.8 billion in the third quarter, so the restocking cycle is starting to accelerate, as businesses appear encouraged by a more business-friendly attitude in Washington.

Net trade positive The trade deficit continued to shrink in the third quarter of 2017, adding 0.41 percentage points to GDP, as exports rose while imports declined. Exports increased by 2.3% in the third quarter, compared with 3.5% and 7.3% increases in the second and first quarters, respectively. That added 0.28 percentage points to GDP, as the relatively weak dollar and strong overseas economies helped to boost exports. Imports, on the other hand, actually declined 0.8% in the third quarter, versus gains of 1.5% in the second quarter and 4.3% in the first quarter, adding another 0.12 percentage points to third-quarter GDP.

Housing doldrums continue The weakest component in today’s GDP report was residential investment, which fell 6% in the third quarter, subtracting 0.24 percentage points from GDP. That’s on the heels of a downwardly revised 7.3% housing-related decline in the second quarter, which marks this sector’s worst 2-quarter performance since 2010. In sharp contrast, housing surged 11.1% in the first quarter of 2017. Housing appears to have peaked in March, as homebuilders are dealing with a shortage of ready-to-build lots and skilled labor, higher prices, and a lack of entry-level buyers, perhaps due to growing levels of college debt. We may see a temporary snap back in housing-related activity as hurricane damage is repaired.

Government spending slips Total government spending, which accounts for about 17% of total GDP, declined for the third consecutive quarter, slipping 0.1% in the third quarter, which subtracted 0.02 percentage points from GDP. That compares with a downwardly revised 0.2% decline in the second quarter and a 0.6% first-quarter decline. Federal government spending actually rose in the third quarter, boosted by a 2.3% increase in national defense spending that added 0.09 percentage points to economic growth. State and local spending collectively fell 0.9%.

Business fixed investment rises Nonresidential real business fixed investment rose for the sixth consecutive quarter, increasing 3.9% in the third quarter, which added 0.25 percentage points to GDP. That compares with gains of 6.7% and 7.2% in the second and first quarters, respectively. Looking at the key components, business equipment and software rose for the fourth consecutive quarter (the longest such streak in three years), gaining 8.6% in the third quarter of 2017, which added 0.49 percentage points to GDP. That compares with gains of 8.8% in the second quarter and 4.4% in the first quarter. Moreover, business structure investment—a very volatile category that includes factories and office buildings—declined 5.2% in the third quarter, which subtracted 0.15 percentage points from GDP, compared with strong increases of 7.09% in the second quarter and a robust 14.8% gain in the first quarter. Finally, intellectual property spending rose for the third consecutive quarter by 4.3% in the third quarter, versus 3.7% in the second quarter and 5.7% in the first quarter, which added 0.17 percentage points to GDP. We continue to believe that corporate investment spending could accelerate sharply if President Trump’s business-friendly fiscal policies are eventually passed into law.

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