Consumer drives strong third-quarter GDP
Bottom line Gross domestic product (GDP) grew at a stronger-than-expected annualized pace of 1.9% in the third quarter of 2019, compared with 2% in the second quarter. Although slightly below our 2% forecast here at Federated, it was above the Bloomberg estimate at 1.6%. The Blue Chip consensus and the Atlanta Federal Reserves’ GDPNow estimate both came in at 1.8%. U.S. GDP now approximates $21.5 trillion in current dollars.
Personal consumption was more robust than expected in the third quarter, thanks to a very healthy 4% year-over-year (y/y) gain in Back-to-School (BTS) retail sales, along with positive contributions from government spending and housing, which rose for the first time in nearly two years. But weak corporate spending, a decline in net trade and a modest dip in the pace of inventory accumulation were drags.
Combined with last Friday’s strong labor-market update for August, September and October, this week’s beat at 54.7 on the October ISM services index and the prospect of a skinny Phase One trade deal with China later this month, stocks have surged nearly 8% over the past month to a new record high. The S&P 500 is now within striking distance of our long-standing 3,100 forecast for 2019.
What happened to that inverted yield curve? Amid all this good news on the economy and the financial markets, we continue to believe the Fed is on a self-imposed lock down after last Wednesday’s quarter-point cut. That marked the third decrease in a row, lowering the upper band of the fed funds rate to 1.75%. With benchmark 10-year Treasury yields now around 1.83%, the yield curve is positive again. Perma-bears had been pointing to the inversion as justification for their recession forecast. Our recession dashboard continues to indicate no risk of one before the first half of 2021 at the earliest.
Here are the key details from the third-quarter GDP flash report:
Final sales rise Private domestic final sales—which exclude volatile net trade, inventory building and government spending—are a better indication of underlying fundamental demand. They rose at a healthy 2% pace, though down from the second quarter’s powerful 3.3%.
Consumer spending rises Personal consumption expenditures, which account for nearly 70% of GDP, rose a stronger-than-expected 2.9% (versus an estimated 2.6% gain), compared with 4.6% in the second quarter. That added 1.93 percentage points to overall third-quarter GDP growth versus 3.03 in the second quarter. Retail sales during the important BTS season in July, August and September enjoyed a solid 4% y/y gain, compared with a healthy 3.8% increase in Easter sales during “Mapril.” We expect solid Christmas sales, up 4-4.5%.
Government spending positive Total government spending, which accounts for about 17.5% of total GDP—rose 2% compared with a 4.8% increase in the second quarter. This added 0.35 percentage points to third-quarter growth versus 0.82 in the second quarter, its largest contribution in a decade. Federal government spending rose 3.4% in the third quarter (paced by a 5.2% gain in nondefense spending), while state and local spending rose only 1.1%.
Housing rebounds Residential construction, which accounts for only 3.7% of the economy, rose for the first time in seven quarters due to the sharp decline in mortgage rates. Housing rose 5.1%, which added 0.18 percentage points to GDP growth versus a decline of 3% in the second quarter. But home sales soon may moderate due to the winter, the $10,000 SALT deduction cap impacting high-tax states, elevated home prices, rising labor and material costs, and more than $1.6 trillion in student loan debt impacting millennial first-time home buyers.
Business fixed investment weak Nonresidential real business fixed investment, which accounts for about 13% of the economy, declined for the second consecutive quarter. This 3% decrease subtracted 0.40 percentage points from GDP growth. This compares with a modest 1% decline in the second quarter, as uncertainty concerning the ongoing China trade and tariff war weighed on corporate capex spending. Looking at the three key subcomponents: nonresidential structures plunged for the second consecutive quarter and for the fourth time in the past five quarters, falling 15.3% in the third quarter (the most in four years). That subtracted 0.48 percentage points versus an 11.1% second-quarter decline. Business equipment declined for the second time in the past three quarters, falling 3.8% in the third quarter, which subtracted 0.23 percentage points compared with a modest 0.8% second-quarter gain. Amid the ongoing technology upgrade cycle, intellectual property remains the lone capex star, rising 6.6% in the third quarter, adding 0.30 percentage points versus a 3.6% gain in the second quarter.
Net trade remains under pressure The continued deterioration in net trade during the third quarter, largely due to the ongoing trade and tariff skirmish with China, subtracted only 0.08 percentage points from growth, compared with a 0.68 second-quarter drag. Exports (11.6% of the economy) grew 0.7% in the third quarter, adding 0.09 percentage points, compared with a sharp 5.7% second-quarter decline. Imports (14.6% of the economy) rose 1.2% in the third quarter, subtracting 0.17 percentage points versus a marginal 0.01% second-quarter increase. If the U.S.-China trade deal is completed later this year, boosted exports to China likely would reverse this negative trend.
Pace of inventory growth slows modestly Inventories rose $69 billion, down slightly from the second-quarter’s $69.4 billion, which reduced GDP growth 0.05 percentage points. With an unsustainable first-quarter inventory build of $116.0 billion, which had added a robust 0.53 percentage points, we were expecting some payback.