The news over the past month – from Charlottesville to Houston to Pyongyang – has been awful. Except for the economic news, which continues to be positive. The bad non-economic events certainly raise the level of uncertainty, but (so far) without much impact on the economy or our forecast, which remains little changed.
NIPA Data
The second release of data for second quarter contained modest improvement from the advance data a month ago. Real output growth was raised by 0.4% to 3.0%. The higher estimate came from stronger consumer spending (growth raised to 3.3% from 2.8%) and stronger business investment (growth of 6.9% vs. 5.2%). This was partly offset by reduced estimates for government spending, both federal (mainly defense) and especially state and local. The latter is now estimated to have declined at a 1.7% rate in Q2. Residential investment and inventory accumulation were little changed, as was the trade deficit (due to downward revisions to both sides). Overall a solid quarter, with the business investment performance particularly encouraging.
Recent Data
Monthly data for the third quarter are likewise mildly encouraging, especially those that are qualitative in nature.
The Conference Board consumer confidence index rose for the third straight time in August. The rise is driven by a very positive judgment of the present situation, which is at its highest reading since 2001. Expectations about the short-term outlook were about flat, although at a relatively optimistic level. On the business side, both ISM indexes were up in August. Manufacturing rose by 2.5 points to 58.8, its highest reading since 2011. Their non-manufacturing measure increased 1.4 points to 55.3.
Concrete indicators are less impressive. In the industrial production data from the Federal Reserve, manufacturing in July was flat with June and up only 1.2% from a year ago. Total IP is doing better (up 2.2% yoy), but entirely due to an energy related surge in the mining sector. The housing sector continues to disappoint with both starts and building permits down in July. Auto sales registered a disappointing 16.1 million rate in August, down for the fourth month in a row. The August rate is down 2 million from its rate in December. Consumer spending overall, however, remains healthy, growing at about a 3% annual rate in July and also over the past six months and the past year. Growing income and a favorable labor market supports this growth.
Regarding the latter, the August employment report was slightly below expectations. Payroll employment rose 156 thousand, and the gains in June and July were reduced by 41 thousand. The private sector numbers look better, however, with an August increase of 165 thousand and a plus 10 thousand adjustment to previous months. [This implies weakness in the government sector: - 9 thousand in August; -51 thousand in revisions.] In the household survey the unemployment rate was up from 4.3% to 4.4% and the participation rate unchanged at 62.9%.
Overall the new data are strong enough to justify a continuation in the third quarter of the solid Q2 outcome.
Baseline Forecast
As shown in the chart, this is what our model produces. Over the final two quarters of this year our baseline forecast has the economy growing just below 3.0%, equal to the second quarter rate. This is a little deceiving since some of the growth is due to inventory accumulation rising toward a more normal level than its barely positive Q2 reading. Beyond this our forecast has modest decelerations in consumption and business investment partly offset by improvement in housing and government spending.
Summary
We think that the economic risks to this forecast are about balanced between the upside and the downside. But these are minor compared to non-economic issues. First, there is the reality of Harvey and the possibility of Irma. This cuts both ways. In the short-run there will be significant disruption (e.g. to refining and transportation), which could reduce activity in Q3 relative to our forecast. A little farther out rebuilding will generate a positive impact that could raise activity during 2018. Second, there is the Washington mess. It looks as though the debt ceiling/government shutdown can has been kicked to December. That produces negative possibilities for then. On the other hand, successful tax reform would be a positive, although one with low probability of occurrence.