Editor’s Note: This post was originally published on 2 July 2018 on Patreon.
The latest revision to the GDPNow tracker came in at 4.1% growth today. With Q2 now over, we are going to get just a few more data points before the first GDP growth estimate is released at the end of the month. I continue to believe we will see the numbers well above 3% in real terms. And the forward looking indicators suggest this momentum will continue well into the future.
Support for growth from personal outlays looks good
At its core, real GDP is about consumption because that counts for two-thirds of GDP and because income and consumption drive investment over the longer term. The personal outlay numbers released on Friday were good. Personal outlay growth is rising modestly. And nothing on the horizon suggests that growth will moderate significantly near term. Below you can see the trend over the past business cycle.
Source: BEA, St. Louis Fed
The GDPNow real growth figure came down from an abnormally high 4.5% to just 3.8%. The decline was due to the outlay figures showing more of 3%ish real growth than the 4%ish growth that the GDPNow tracker had been tracking over the first two months of the quarter:
The GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the second quarter of 2018 is 3.8 percent on June 29, down from 4.5 percent on June 27. The nowcast of second-quarter real personal consumption expenditures growth declined from 3.7 percent to 2.7 percent after this morning’s personal income and outlays report from the U.S. Bureau of Economic Analysis.
-Atlanta Fed GDPNow statement release, 29 Jun 2018
These figures give the Fed room for additional tightening
But let’s remember that 3%ish real growth is what Trump wants. And it also something the Fed has said it believes is above the long-term potential growth rate for the US economy. So if personal outlays in the US are growing at 3%, not only are we well above stall speed where a recession is a threat to the economy but we are also at a level that will draw a hawkish response from the central bank.
Think of the Fed as having a tightening bias. And what that means is they are looking for scope to tighten further. Since the numbers show the US economy with almost zero chance for recession in the near term, the Fed has a green light to tighten further still going forward.
And as I have been saying for some time now, I think this means a more aggressive quantitative tightening is in the cards going forward.
Capital investment numbers look good too
From a cyclical perspective, we are at a good spot right now. Not only are personal income and personal outlays growing at a good clip, so too is investment. Today’s GDPNow figure of 4.1% was an upgrade due to the non-residential investment data that came out today. Here’s what the Atlanta Fed said about the figures. Pay attention to the part I have underlined and bolded.
The GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the second quarter of 2018 is 4.1 percent on July 2, up from 3.8 percent on June 29. After this morning’s construction spending report from the U.S. Census Bureau, the nowcast of second-quarter real government spending growth increased from 0.8 percent to 1.6 percent, while the nowcast of second-quarter real nonresidential structures investment growth decreased from 7.6 percent to 5.3 percent. The nowcasts of second-quarter real consumer spending growth and second-quarter real nonresidential equipment investment growth increased from 2.7 percent and 4.0 percent, respectively, to 2.9 percent and 4.8 percent, respectively, after this morning’s Manufacturing ISM Report On Business from the Institute for Supply Management. The model’s estimate of the dynamic factor for June—normalized to have mean 0 and standard deviation 1 and used to forecast the yet-to-be released monthly GDP source data—increased from 0.15 to 0.77 after the ISM report this morning.
I would look at the investment figures as moving into a cyclically high position relative to consumption. That means capital investment will cause GDP growth to increase by a greater percentage than consumption growth. And again, this will give the Fed scope for tightening, especially to the degree it believes the commercial property market is overheated.
A closer look at the ISM figures
Here’s what the manufacturing sector looks like right now. Pay attention to the highlighted sections.
Anything above 60% is very robust. All of the highlighted figures are above 60%, showing a wide swathe of areas in the manufacturing sector experiencing growth.
The bottlenecks in terms of production are one area to watch. The ISM report says, for example:
The delivery performance of suppliers to manufacturing organizations was markedly slower in June, as the Supplier Deliveries Index registered 68.2 percent. This is 6.2 percentage points higher than the 62 percent reported for May. “This is the 21st straight month of slowing supplier deliveries that continue to constrain production growth and inventory expansion. Lead-time extensions for production materials, transportation delays, and ongoing uncertainty in the steel and aluminum markets continue to restrict production output. The index recorded its highest reading since May 2004, when it reached 68.3 percent,” says Fiore. A reading below 50 percent indicates faster deliveries, while a reading above 50 percent indicates slower deliveries.
That’s where the prices paid component can continue to remain elevated, leading to inflation. The budding trade war in steel and aluminum is adding to the problem.
Be bullish on the economy
These are good numbers, folks. Anyone talking down the US economy right now isn’t speaking from a position of knowledge or objectivity. But not only are the numbers good, the forward-looking indicators are also good. Nothing I see in these numbers suggests a slowdown is in the making.
The Fed is likely to continue to talk up the US economy. And I believe markets will react. With the yield curve at 32 basis points spread between 2- and 1-year Treasuries, we still have scope for further curve flattening. We are already close enough to my 25 basis point prediction that I will call my goal met on this front.
In the short-term, perhaps you get a mild selloff in long bonds due to overbought conditions. But as the second half of the year takes shape, I expect the curve to move down to near completely flat, with inversion likely in the beginning of 2019 if not sooner.
As far as stocks go, that means you have room to run despite the selloff in financials this past month. I don’t think the bull market is over by a long shot yet.