US economic data continues to impress. GDP grew by 3.0% q/q (annualized) in Q3 despite a negative impact from hurricanes. I had expected 2.5% quarterly growth, but the large positive contribution from inventories (0.7pp) pushed up the overall growth rate more than I had expected. This could be reversed in Q4.
While the loss of 33,000 jobs in September stands out as the weakest recent economic data point, job creation in hurricane-stricken Texas and Florida (at -134,000) was 174,000 below recent trends in those states. Reversing most of the job losses could make for job gains of 300,000 in October.
Equipment investments starting to impress
The most encouraging contribution to growth in Q3 came from equipment investment with another +8% quarterly growth. Business confidence indicators point to continued high growth in business investments. Durable goods orders increased by 2.2% m/m in September with orders for core durable goods advancing 1.3%. Orders for computers and machinery were up 7% on 2016. I look to both these components as indicators of increased focus on productivity, and I expect them to show substantial growth in the coming year. Private non-residential structure investments have been weak of late due to lower oil prices, but with WTI crude oil prices above USD50 per barrel, a renewed pickup in drilling activity should materialize during Q4.
Residential investments declined again in Q3, mainly due to lower turnover in the housing market. Pending home sales were flat in September compared to August and down more than 5% on the year. Very tight supply continues to dampen turnover in the existing-home market. While new house sales picked up substantially in September (up 17% on 2016), most of the jump was in the South and probably a result of destroyed homes after the hurricanes. This should – along with home refurbishment articles – contribute positively to growth in the near term.
Steady growth in private consumption
Consumption grew by 2.4% causing the savings rate to decline from 3.8% to 3.4% in Q3 (3.1% in September) with some additional leveraging. The hurricane-induced jump in auto sales in September to 18.6 million units (annualized) brought growth in durable-goods consumption to 8.3% q/q. While still providing a solid foundation for economic activity, I do not expect households to be the driver of growth in the coming quarters as sales of new autos are to weaken again. A glut of used autos continues to push down prices. Furthermore, the already significant decline in the savings rate leaves less room for further declines.
However, the latest consumer confidence indicators confirm a high degree of optimism with Michigan consumer confidence at a 13-year high and Conference Board confidence at elevated levels; the assessment of the present situation is at a 16-year high, while the expectations (more strongly correlated with private consumptions) equal the boom years prior to the crisis. The senior loan officer-report continues to show increased willingness to make consumer loans, so the financial sector is not restricting borrowing.
Non-federal public spending declining
Public spending continues to be a drag on economic growth, although defense spending has started to increase. The Republicans have included further provisions for defense equipment in the just-approved budget resolution, which should support growth going forward. Increased export of military gear to allies should also add to exports.
Most of the decline in public spending comes from state and local government investments, subtracting 0.17pp from GDP growth in Q3. Local governments remain under substantial financial strain with a net borrowing of almost USD200 billion in 2016. If Republicans include some reduction in the deductibility of local and state income taxes in the tax plan, a further squeeze on spending can be expected. Cuts to the investment budget runs counter to the President’s desire to create a massive infrastructure package.
Net export contribution above trend
Net export contributed 0.4pp to growth as exports of both goods and services increased, while imports declined. Declining imports is not a long-term thing, and future revisions to the GDP numbers could well show stronger imports. Q3 marked the second quarter in a row with a positive trade balance in natural gas, highlighting the sector’s increasing importance to the overall trade balance – especially with Mexico. Pipeline capacity is doubling between 2016 and 2018 to 14 billion cubic feet per day, replacing Mexico’s current LNG import and meeting increased demand as power generation from natural gas plants expands.
Positive near-term outlook
I expect growth in private demand to maintain a steady pace going forward. The federal brake on new regulation have created a more certain framework for businesses and some modest tax cuts should sustain domestic spending, although disappointment looms compared with lofty expectations in financial markets. Economic growth moving up to the 2.5-3.0% range (I expect 2.7% GDP growth for 2018) should sustain continued interest rate normalization – and some dollar appreciation – over the coming months. There is still very little market-based inflation in the US, and more investment in productivity-enhancing technologies is likely to keep labor cost under control.