United States Forecast Summary
The economy seldom makes it easy to discern its underlying trend. The current period is definitely not an exception. But we think the trend is one of gradual improvement, and we think this pattern will continue for the rest of this year.
The second release of the second quarter National Income and Product Account (NIPA) data were generally similar to initial estimates. GDP growth was raised by 0.3% to 4.2%, and less of the growth was due to inventory accumulation. Growth in final sales (that is, ignoring inventory change) is now put at a healthy 2.8%. At a disaggregate level the only notable revisions were to business investment in equipment and in structures. Growth in the former was raised nearly four percent to a 10.7% rate, while the latter went up over 4 percent to 9.5%.
Overall the second quarter was encouraging in several regards. To begin with it provides pretty a convincing indication that the negative first quarter was an aberration. Second, domestic demand showed the pattern that we have long felt would be required for the economy to move above the two percent growth that characterized the “recovery” until recently. Consumption grew by 2.5% – not great, but adequate; business investment rose 8.5%, which is more than enough to power faster growth; government spending grew 1.4%, finally breaking its long string of negative growth. Finally, over the past four quarters GDP has grown 2.5%, a long enough period to suggest that growth has indeed accelerated a little.
Recent Monthly Data
Monthly indicators generally provide confirmation for this conclusion, but also suggest that it would be wise not to get carried away with enthusiasm. On the positive side July housing starts and industrial production numbers were strong. August consumer confidence remained strong (in the face of a lot of discouraging news on the international scene), and auto sales were very strong. Both ISM indices posted increases last month from already very high levels.
But there were some weak numbers as well. Consumer spending in July was uninspired. And the August employment report was a significant surprise on the downside. Payroll employment rose just 142 thousand, breaking a six-month run of 200 thousand plus. Some of this was special factors relating to strikes and auto model changeover, but by no means all. The household survey had unemployment a tick lower at 6.1%, but mostly due to decrease in the labor force rather than increase in employment. One month does not make a trend, but our optimism will be shaken if we see another weak report for this month.
Except for the employment report, which for now we are willing to treat as a cautionary random blip, the past month’s data are fully consistent with our basic scenario that the U.S. economy is moving from an extended period of subpar growth (i.e. around 2%) into a period of growth averaging close to potential (i.e. a little below 3%). As a result our forecast is very little different from a month ago. We now expect the current quarter to come in at 2.9%, up 0.1% from our August outlook. For the next year we also have growth at 2.9%, which is unchanged from August. Compared to the past two years, the modest improvement we see is due to acceleration across most of the economy. Business investment shows the largest change moving from growth that has averaged 4.1% the past two years to growth of 6.8% over the next four quarters. There is a quantitatively similar change in government spending growth, which moves from -1.3% to +1.1%.
We think the economy remains on a trajectory toward a period with output growth averaging about three percent. There is some upside potential, if business begins to feel a little of Keynes’ animal spirits or if consumers begin to spend more freely, especially on services. We continue to have concerns, however, about the potential impact of Federal Reserve tightening, which we expect to start toward the middle of 2015.