The headline real GDP figure for the second quarter was slightly weaker than expected, but the underlying details of the report pointed to considerable strength. In fact, the report suggests that the economy is not only hot right now, but that it likely has considerable staying power.
Some of the most important developments in Friday’s data pertain to the consumer. Consumer spending in the second quarter, adjusted for prices, surged at a 4.0-percent annualized pace, well above expectations of a 3-percent rise.
{mosads}The second quarter rebound followed a disappointing 0.5-percent gain in the first quarter, a performance that was dinted by difficult winter weather. An easy conclusion for casual observers to draw would be that the pop in the spring reflects a “sugar high” from tax cuts that will quickly dissipate. However, the notion of a Q2 sugar high is not fully consistent with the data.
The average gain over the first half of the year was only 2.2 percent, short of the increases seen in 2016 (2.7 percent) and 2017 (2.5 percent). Thus, households have not spent at an unsustainable pace so far this year.
In fact, consumption is likely to accelerate in the second half of the year (from the first half average, not from Q2’s 4.0-percent jump).
More importantly, benchmark revisions to the history of the GDP data show that household income was far stronger than previously thought. The Bureau of Economic Analysis incorporated new data sources, mainly tax return data from the IRS, that led them to make massive upward adjustments to personal income over the past several years.
The 2017 tally for personal income was lifted by a whopping $400 billion, and the savings rate was double the prior estimate (6.7 percent, vs. a pre-revision 3.4 percent figure). Thus, it turns out that consumers have far more wherewithal to spend than the data previously suggested.
While real spending gains are likely to settle back to a 2.5-3.0-percent pace going forward after the Q2 weather-affected bounce, there is no reason to fear a sustained slowdown in consumer spending for the foreseeable future (as long as the robust labor market continues to kick off sizable income gains).
Meanwhile, business investment remained on a tear. Business investment in structures, equipment and intellectual property barely rose at all in 2015 and 2016 (+1.8 percent and +0.5 percent, respectively) before accelerating to a solid 5.3-percent rate of increase last year.
On the back of the December passage of corporate tax reform, businesses have unleashed the purse strings so far this year. Business investment has surged at a 9.4-percent annualized pace in the first half of 2018.
Most encouragingly of all, businesses have spent much more on “intellectual property,” a category that encompasses a number of line items (e.g. computer software) that should correlate with innovation.
For an economy that has suffered from anemic productivity growth for almost a decade, a significant pop in business investment is not only a welcome sight in terms of boosting growth in the short term but is also just what the doctor ordered to hopefully boost productivity gains and in turn the trend pace of economic growth for years to come.
The economy managed to grow by more than 4 percent in the second quarter despite the fact that firms shed inventories at the fastest quarterly pace since 2009.
Surveys indicate that firms view their current inventories as too low and are looking to rebuild them going forward. This restocking is likely to provide a tailwind to economic growth in the second half of the year.
Finally, the trade deficit narrowed substantially in the spring. The trade category often exhibits wild quarterly swings, so it is premature to say what may be behind the move in the spring.
President Trump would have us believe that his trade policies are producing a sustained decline in the trade gap. Others have suggested that exports were expedited to beat the imposition of retaliatory tariffs in July.
I have penciled in a widening in the trade gap for the summer, but the volume of trade flows in future years could be sharply higher or lower, depending on the eventual result of the current trade negotiations.
In any case, I am skeptical that the trade deficit will shrink markedly in the near term, as the U.S. economy is stronger than that of most of our trading partners and in an economy suffering from a shortage of skilled labor, importing more to satisfy robust consumer and business demand can be a vital release valve.
Overall, the-second quarter GDP release points to an economy with remarkable momentum, as both consumers and businesses are in a position to continue spending heartily for the foreseeable future.
Trade negotiations represent a key wild card, but the most likely scenario is that economic growth will continue to exceed 3 percent on average in the second half of the year.
Stephen Stanley is the chief economist for Amherst Pierpont Securities, a broker dealer providing institutional and middle-market clients with access to fixed-income products.