Orlando's Outlook: Robust second-quarter GDP

07-27-2018

Bottom line Gross domestic product (GDP) grew at a robust annualized pace of 4.1% in the second quarter of 2018, marking the strongest quarterly growth rate in nearly four years, nearly double the first quarter’s upwardly revised pace of 2.2%. GDP in the U.S. is now slightly more than $20.4 trillion.

Last December’s structural fiscal policy reform, which included personal and corporate tax cuts, repatriation and the immediate expensing of capital equipment purchases, has sparked a healthy labor market, a surge in consumer spending, a sharp improvement in net trade and a strong increase in capital spending (capex), which collectively helped to drive today’s powerful GDP report.

But today’s news wasn’t universally positive, as a surprising inventory liquidation and continued weakness in the housing market were drags on second-quarter economic growth. Government spending made a modestly positive contribution.

Today’s second-quarter report was spot on with our 4.1% forecast here at Federated. The Bloomberg consensus was 4.2%, the Blue Chip consensus estimate was 3.9% and the Atlanta Fed’s volatile but widely followed “GDPNow” estimate was lowered just this week from 4.4% to 3.8%.

In addition, the Commerce Department issued its comprehensive benchmark revisions today (see chart at bottom), which it does every five years, reviewing various metrics dating back more than 70 years. Two highlights: Commerce now believes it has finally fixed the seasonality problem that has artificially depressed first-quarter GDP. It now calculates it has grown at an average annual pace of 1.6% from 2002 to 2017 versus its prior estimate of 1.2%. Commerce also revised the savings rate substantially higher in 10 of the last 11 years, as it discovered that income and savings for small business owners were much larger than previously believed. So the savings rate in 2017 was 6.7%, up sharply from previous estimates of 3.4%.

All told, we do not believe that there was anything in today’s powerful GDP report that might dissuade the Federal Reserve from hiking interest rates a third time this year in September and continuing to shrink its $4.5 trillion balance sheet over time. In our view, this may contribute to the 5-8% equity-market correction we’ve been forecasting for the third quarter.

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

Consumer spending surges Personal consumption expenditures, which account for 70% of GDP, rose by a much stronger-than-expected 4% in the second quarter, versus consensus expectations for a 3% increase. That’s a huge jump from the first-quarter’s paltry, downwardly revised 0.5% rise. Today’s gain added 2.69 percentage points to overall second-quarter GDP growth. Because of lower personal taxes and a healthy labor market, we had expected a huge consumer-driven rebound in second-quarter GDP, as the powerful bounce we’ve enjoyed in consumer spending from March through June compares favorably with miserable trends in January and February. We expect this positive trend to continue in the second half of 2018, with strong Back-to-School (BTS) and Christmas spending.

Stronger net trade With all of the noise emanating from Washington recently on potential trade wars, there was a second-quarter surge in shipments of goods overseas (particularly soybeans and petroleum products) ahead of retaliatory tariffs. As a result, exports soared 9.3% in the second quarter, compared with 3.6% in the first quarter of 2018, which added 1.12 percentage points to GDP growth. Imports rose a modest 0.5% in the second quarter versus a stronger 3% gain in the first quarter, which subtracted 0.06 percentage points from second quarter GDP. So, net exports declined by $850 billion in the second quarter, which added 1.06 percentage points to GDP, the most since 2013. This robust pace of export strength may not be sustainable.

Business fixed investment rises Nonresidential real business fixed investment rose for the ninth consecutive quarter by 7.3% versus a stronger 11.5% gain in the first quarter of 2018, which added 0.98 percentage points to GDP. Looking at the key subcomponents, structures soared 13.3% in the second quarter, compared with 13.9% in the first quarter, which added 0.39 percentage points to GDP. Business equipment and software rose for the seventh consecutive quarter, rising 3.9% versus 8.5% in the first quarter, which added 0.23 percentage points to GDP. Intellectual property rose 8.2% versus a stronger 14.1% increase in the first quarter, which added 0.35 percentage points to GDP.

Modest increase in government spending Total government spending, which accounts for about 17% of total U.S. GDP, rose for the third consecutive quarter by 2.1% in the second quarter, compared with a 1.5% gain in the first quarter of 2018, adding 0.37 percentage points to GDP. Federal government spending rose 3.5% (the second-fastest increase since 2014, paced by a 5.5% increase in national defense), while state and local spending rose 1.4%.

Housing declines again Residential construction fell for the fourth time in the past five quarters, declining 1.1% in the second quarter of 2018 versus a 3.4% decline in the first quarter, which subtracted 0.04 percentage points from GDP. That the peak home-building season is rapidly passing us by doesn’t bode well for a third-quarter rebound.

Inventory liquidation Inventories actually declined by a surprising $27.9 billion in the second quarter of 2018, compared with a strong increase of $30.3 billion in the first quarter, which subtracted 1 percentage point from GDP growth, the most since 2014. To a significant degree, this reduction in inventories was related to the surge in exports of soybeans and petroleum products. We expect this negative trend in inventory liquidation to reverse itself over time, particularly as the fears of a trade war diminish and as businesses begin to build inventory ahead of the BTS and Christmas seasons.

Final sales strong Private domestic final sales—which exclude volatile net trade, inventory building and government spending—rose at a strong 4.3% pace in the second quarter, the second-fastest pace since 2014. Many economists point to this metric as a better indication of underlying fundamental demand.

GDP revisions The following table reflects today’s comprehensive benchmark revisions from the Bureau of Economic Analysis (BEA) from 2013 through today’s second-quarter flash:

QuarterPrevious GDPNewly Revised GDPChange
1Q13 2.8% 3.6% 0.8%
2Q13 0.8% 0.5% -0.3%
3Q13 3.1% 3.2% 0.1%
4Q13 4.0% 3.2% -0.8%
Full Year 2013 1.7% 1.8% 0.1%
       
1Q14 -0.9% -1.0% -0.1%
2Q14 4.6% 5.1% 0.5%
3Q14 5.2% 4.9% -0.3%
4Q14 2.0% 1.9% -0.1%
Full Year 2014 2.6% 2.5% -0.1%
       
1Q15 3.2% 3.3% 0.1%
2Q15 2.7% 3.3% 0.6%
3Q15 1.6% 1.0% -0.6%
4Q15 0.5% 0.4% -0.1%
Full Year 2015 2.9% 2.9% 0.0%
       
1Q16 0.6% 1.5% 0.9%
2Q16 2.2% 2.3% 0.1%
3Q16 2.8% 1.9% -0.9%
4Q16 1.8% 1.8% 0.3%
Full Year 2016 1.5% 1.6% 0.1%
       
1Q17 1.2% 1.8% 0.6%
2Q17 3.1% 3.0% -0.1%
3Q17 3.2% 2.8% -0.4%
4Q17 2.9% 2.3% -0.6%
Full Year 2017 2.3% 2.2% -0.1%
       
1Q18 2.0% 2.2% 0.2%
2Q18 --- 4.1% ---

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