Since the beginning of 2017 year-over-year growth in real GDP has risen steadily by a full percentage point to 2.8%. Except for a stimulus driven four quarters in 2009-10 and a period during the fracking boom in 2014-15, this is the past four quarter growth is the best of the nearly nine year recovery. Our forecast has the current period of accelerating growth continuing into early 2019. Recent data are consistent with this optimistic outlook. At the same time, however, risks are rising.
NIPA Data
The second release of data for the first quarter lowered estimated real GDP growth from 2.3% to 2.2%. All of the change and then some came from a lower estimate of inventory accumulation. Most of the components of spending – consumption, housing, government, trade – had small negative revisions. However the quantitatively most significant was a substantial increase in business investment, with all three subcomponents revised upward. The largest adjustment came in intellectual property arising from increased spending on software.
Recent Data
Monthly data during April generally reversed their slightly negative March movements.
April industrial production was up 0.8% (monthly rate) putting its rise over the past twelve months at a strong 3.5%. The ISM manufacturing index for May came in at a strong 58.7, up 1.4 points from April. Durable goods orders fell 1.7% (monthly rate) in April, but that was entirely due to a large drop in the highly volatile aircraft category. Excluding transportation orders for the month were up 0.9%. Overall orders were up 9.6% from April 2017.
April consumer spending adjusted for inflation increased 0.4% in April (monthly rate), with year-over-year growth a healthy 2.7%. Consumer confidence rose in May and auto sales had a good month. Less positive, housing starts declined in April, remaining in a narrow range around a somewhat discouraging 1.3 million annual level.
Finally, April employment data was quite positive. The establishment report was strong in all regards. Total employment rose by 223 thousand, with an additional 15 thousand in revisions to March and April. The increase was spread across all major sectors. The household survey also had considerable good news, but with one darkish cloud. Unemployment went down a tick to 3.8%, matching April 2000 as its lowest reading since 1969 (when it was as low as 3.4%). The rate for African Americans fell to 5.9% (down 0.7%) and that for those without a high school diploma to 5.4% (down 0.5%). These are the lowest readings on record (data go back to 1972 and 1992, respectively). The only blemish in the report was a second month of discouraging labor force data – up by just 12 thousand, following a 236 thousand decline in April. The labor force participation rate fell another tick to 62.7%.
Overall, both the NIPA data and the monthly numbers increase our confidence in our positive outlook for the rest of this year. Except for the labor force number, the prospects of 2019 are encouraging as well.
Baseline Forecast
As can be seen in the chart, our updated forecast shows a little more growth during the remainder of 2018 than in our outlook a month ago. The difference amounts to just under 0.2% (3.6% versus 3.4%). Our growth estimate for 2019, by contrast, is slightly reduced (2.8% versus 2.9%).
Compared with the past five quarters, our forecast for the rest of 2018 has 1.1% higher growth. This is accounted for by stronger investment (both business and residential) and a surge in federal government spending, partly offset by more rapid growth in the trade deficit.
Risks
We see three potential obstacles to our optimistic scenario.
First, and least important, is that housing could fall short of our expectation. There is certainly no sign of a pickup so far.
Second, lack of labor force growth increases our worries that a tight labor market will start to push inflation higher. This process could work in two ways. One is the classic Phillips curve pressure on labor costs. The second is that firms facing supply constraints due to labor shortages will ration available output by raising prices. Again there is little sign of this in the data, although there are more and more anecdotal indications.
Finally, the international environment is increasingly worrying. President Trump and his advisers seem driven to ignite a trade war. The names Ross and Navarro may go down in history next to Smoot and Hawley. In addition strains in the international financial system (e.g. from Italy) and in the geopolitical realm seem to be rising, and economic growth outside the U.S. seems to be sputtering.