U.S. Economy Picks Up Where It Left Off
As the effects of Hurricanes Harvey and Irma continue to fade from the economic data, it becomes increasingly clear that the storms did not disrupt the considerable momentum the U.S. economy carried into the back half of 2017. An economic expansion that has from the start confounded expectations, for both negative (the slowest on record) and positive (it will soon become the second longest on record) reasons, is in the midst of what, for lack of a better term, we’ll call a late-cycle acceleration. Should the expansion continue to defy expectations however, the “late-cycle” phase could last for quite some time to come, but at the same time will pose considerable challenges for policy makers.
Incorporating more complete and revised source data, the Bureau of Economic Analysis (BEA) now estimates real GDP grew at an annualized rate of 3.3 percent in Q3, up from the initial estimate of 3.0 percent. Fixed investment, the rate of inventory accumulation in the nonfarm business sector, net exports, and government spending were all revised higher relative to the initial estimate. With the upward revision, real business investment in equipment and machinery is now reported to have risen at an annualized rate of 10.4 percent in Q3, following annualized growth of 8.8 percent in Q2. Our baseline forecast anticipates another double-digit increase in Q4.
It is, however, worth putting the recent run of solid growth in business investment in proper perspective. Over much of the current expansion, business investment has been a notable laggard, contributing much less to top-line real GDP growth than has been the case in past expansions. Moreover, weak business investment is a primary factor behind what remains an anemic trend rate of labor productivity growth, which in turn has had negative implications for wage growth. As a result of a prolonged period of weak business investment spending, the solid gains in Q2 and Q3 only nudge the contribution to top-line real GDP growth up against the historical average. We see considerable upside potential for business investment over coming quarters, particularly given that the tax legislation now working its way through Congress contains a provision allowing for immediate expensing of such investment.
After two monthly reports significantly skewed by noise from Hurricanes Harvey and Irma, a relatively noise-free November employment report shows the labor market, like the broader economy, remains firmly on track. Total nonfarm employment rose by 228,000 jobs in November, with private sector payrolls up by 221,000 jobs. The length of the average workweek rose by one-tenth of an hour in November. While this may seem a trivial change, keep in mind that each one-tenth of an hour increase in the workweek is equivalent to adding over 300,000 private sector jobs in terms of the economy’s productive capacity. But, at 34.5 hours, the workweek is still short relative to past instances of tight labor market conditions. We have often referred to the shorter workweek as an underappreciated form of labor market slack, and firms still have ample capacity to add to their total labor input by adding hours for their current workers, which you would expect to be the case if firms were truly “running out of workers.”
The longer workweek also had a powerful impact on aggregate private sector wage and salary earnings. Aggregate wage and salary earnings account for the number of people working, the numbers of hours they work, and how much they earn for each hour they work. While it is the latter component, i.e., average hourly earnings, that gets almost all of the attention, the reality is that the aggregate is what matters in driving growth of consumer spending. While average hourly earnings rose a smaller than expected 0.2 percent in November, aggregate private sector earnings were up by 0.7 percent, leaving them up 4.8 percent year-on-year, the largest such increase since January 2016.
Another notable element of the November employment report is the increase in retail trade payrolls. Not the gain of 18,700 jobs reported in the seasonally adjusted data, but the gain of 451,600 jobs reported in the not seasonally adjusted data. This is the largest increase in retail trade employment for the month of November – the height of holiday-related retail hiring – since 2012. At the same time, hiring in transportation, warehousing, and delivery operations, i.e., activities associated with online shopping, was also strong this November. In short, retailers are expecting a strong holiday sales season, which in turn reflects the strength of the underlying drivers of consumer spending.
The FOMC is almost universally expected to raise the mid-point of the Fed funds rate target range at their December meeting, despite the stubborn refusal of inflation to approach the FOMC’s 2.0 percent target rate. The Committee will also release updated economic and financial projections, including an updated “dot plot.” We will caution, however, that this edition of the dot plot will have little signaling power given what will be significant changes in the composition of the FOMC over coming months, which includes the looming departure of Fed Chairwoman Janet Yellen.
Raising the funds rate this month may be the easiest decision the FOMC takes for some time to come, as their job will become considerably more challenging in 2018 and beyond. What will be a revamped FOMC will have to navigate a course that will almost surely include significant tax cuts for the corporate sector, significant changes in personal taxes, an increasingly tight labor market, firming global growth, and an uncertain inflation outlook. The challenge for the Committee will be to fend off a significant increase in inflation while allowing the expansion to endure while at the same time watching for signs of significant imbalances in asset prices. As such, there is ample room for policy missteps, and also ample room for more volatility in financial markets than has been seen for much of 2017.
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