08 September, 2017
Economy continues to weather risks
The economy continues to perform well, even as new risks emerge. Real GDP growth during the second quarter was revised upward from 2.6 percent in the advance estimate to 3.0 percent in the second estimate. Consumer spending and corporate investment drove this revision despite some minor drag from government spending. Three-percent growth represents the fastest quarterly growth rate since the first quarter of 2015, which was also the last time the quarterly growth rate exceeded 3 percent.
We expect the mid-year momentum generated by the economy to persist in the third quarter, even if growth slows a bit.
This pattern mirrors the trend during most (though not all) of the economic recovery: slow economic growth early in the year that accelerates in the middle two quarters.
Job growth? No problem. Wage growth? Um…
The labor market continued to churn out jobs at an impressive rate. An estimated 156,000 net new jobs were created in August, in line with our expectations. Through August, job creation has averaged 176,000 net new jobs per month with revisions to prior months subtracting 41,000 jobs. Although job growth has been slowing over the last few years, this remains a strong showing for the labor market in its eighth calendar year of job growth. And as we have mentioned, a lack of people to fill those jobs – rather than a lack of willingness to hire – is causing this slowdown. The most recent data available shows that open but unfilled positions reached 6.2 million at the end of June, a new post-recession high.
The sticking point in the labor market remains wage growth. Average hourly earnings increased by 2.5 percent over the last year, which is unchanged since April and identical to the earnings increase last August. As we have repeatedly mentioned, this makes sense in the context of weak productivity growth and low inflation. Although these measures do not move in lockstep, wage growth anchors to inflation and productivity. Over the last four and half years, these two measures have deviated at times, but typically not for long periods. Taking periods of positive and negative deviations into account, the average difference since the beginning of 2013 registered just 30 basis points, when measured on a year-over-year, 12-month rolling basis.
This level of wage growth should enable the Fed to begin normalizing its balance sheet during the fourth quarter. But, unless inflation makes a surprising upward move (which it could due to weakness in the dollar and some upward pressure on energy prices) a third Fed rate hike this year is likely off the table.
Consumers remain upbeat, fueling consumer spending
The strong labor market and a rising stock market fueled upbeat feelings from consumers in August. Both consumer confidence and consumer sentiment (two different measures of consumer feelings) remain high. Consumers became more positive after the presidential election and have largely remained optimistic. That is not to say that strong positive feelings are uniform – rifts certainly exist, such as those between Republicans and Democrats, the old and the young, and the less educated versus highly educated.
On the whole, upbeat feelings have been translating into relatively strong consumer spending growth that exceeds wage growth.
Consumers dipped into savings (the savings rate hit 3.5 percent in July, its second-lowest level since July 2008) and took on record-high levels of leverage. Neither of those can be sustained in the long run which jeopardizes growth and inflation over the last four months of the year.
Harvey's Impact will be felt far and wide for a long time
Hurricane Harvey's impact will be felt nationally and locally, in the short term and the long term. While full assessments have not yet been made, over the short term, Harvey should reduce economic growth in the third quarter by up to 50 basis points. This will come from reduced economic activity, with businesses shut down and consumers focused on survival, not spending. And it has already caused a spike in gasoline prices of roughly 20 cents per gallon over the last couple of weeks. As of last Thursday, 10 refineries representing 16.6 percent of daily U.S. refining capacity were shut down, resulting in a decline of roughly 4.4 million barrels of oil refining production. Over the long run, research shows that hurricanes, particularly destructive ones such as Harvey, do not produce "creative destruction."
While there could be a slight boost to GDP in the next few quarters as rebuilding begins, massive storms like this one produce lasting damage to an economy that can still be felt decades later.
A number of houses and apartment units will be effectively out of inventory for some time, which in the short run should cause an artificial decline in vacancy and rise in rents. Over the medium term, once rebuilding is completed, the Houston market should return to its pre-hurricane trajectory.
What we are watching this week
The focus will be on Washington this week, more than any individual data release. Congress returns from recess this week and will have to deal with the fallout (and cost) from Harvey, just as it contends with the federal budget and the debt ceiling. It is possible that Harvey aid could be tied to either of those, particularly a continuing resolution to fund the government. And the administration is attempting to drum up support for a Republican tax plan, even though details are scarce.
Thought of the week
Hurricane Harvey is likely to be the most expensive natural disaster in U.S. history, with some estimates as high as $190 billion. If that high, the cost would be more than that of Katrina and Sandy combined.