Economy: U.S. Growth Accelerates
Economic reports released in July 2018, largely reflecting economic activity in June, provided evidence of accelerating U.S. economic growth over the second quarter.
The U.S. economy, measured by gross domestic product (GDP), grew 4.1% in the second quarter, its strongest since the third quarter of 2014 and fifth strongest quarter of the expansion. Despite slightly missing the Bloomberg surveyed economists’ consensus of 4.2%, the details behind the report were generally positive, with strong growth despite a big headwind from shrinking inventories and an upward revision to first quarter growth from 2.0% to 2.2%. Fiscal stimulus had a clear impact, reflected in increased government spending, in addition to a strong rebound in consumer spending from first quarter weakness and solid business investment [Figure 1].
The biggest negative on a forward-looking basis was a big jump in exports ahead of the implementation of previously announced tariffs, which is likely to unwind in upcoming quarters. GDP grew at an annualized rate of 3.1% over the first half of the year, so growth could slow some in the second half and the U.S. economy could still grow near 3% for the calendar year, which would be nicely ahead of the expansion average of 2.3%.
Inflation readings reported in July generally exceeded expectations and showed a modest increase in inflation. The core consumer price index (CPI) excluding food and energy increased 2.3% year over year in June. The Fed’s preferred inflation gauge, the core personal consumption expenditures (PCE) deflator, increased 1.9%. The prices paid component of the Institute for Supply Management (ISM) manufacturing survey fell from its May peak at 79.5 to 75.3. Wage growth accelerated slightly but remained within its 2018 range, as average hourly earnings increased 2.7% year over year in June, slightly below May’s 2.8% increase.
Labor markets continue to generate steady improvement. The economy added 213,000 jobs in June, above consensus estimates of 195,000. The unemployment rate rose from 3.8% to 4% for the month, but for a good reason as the labor force participation rate increased from 62.7% to 62.9%. Overall, recent jobs data confirm the labor market is still gradually tightening, but the persistent lack of wage growth won’t force the Federal Reserve (Fed) to speed up its plan for interest-rate increases.
Consumer demand continued to trend higher in June, continuing a solid rebound from the first quarter slowdown. Retail sales grew for a fifth straight month, rising 0.5% in June to match consensus expectations. Initial figures for May were revised higher, from 0.8% to 1.3%, marking the strongest growth rate since September 2017. Eight of 13 subgroups within retail sales gained month over month, confirming a broad-based pickup in consumer activity. Consistent gains in retail sales indicate a healthy consumer amid a strengthening economy. However, control group sales, which are used to calculate GDP, painted a somewhat less encouraging picture, remaining unchanged month over month and falling short of consensus expectations.
Manufacturing activity remained robust in June despite ongoing global trade tensions. The official ISM Manufacturing Index in the U.S. came in at 60.2 in June, above expectations of 58.5 and near the highs of the expansion. The ISM report added to evidence that, as July began, tariffs and escalating trade tensions were having little impact on U.S. manufacturers. Late in the month, several companies reported some drag on their second quarter earnings from tariffs, but overall results through July were quite strong and reflected minimal impact.
The Conference Board’s Leading Economic Index (LEI), an aggregate of ten leading indicators, rose 0.5% month over month in June and 5.8% year over year, above expectations and the prior month. This increase in the LEI is consistent with continued growth in the U.S. economy and low odds of recession in the coming year [Figure 2]. The biggest positive contributor was the ISM New Orders, while building permits detracted most.
The Fed’s Beige Book released in July noted economic conditions were steady with employment gains picking up and wage pressures building at the end of the second quarter. Respondents noted that price pressures remained modest; however, rising trade tensions did in fact increase the prices of some key production inputs.
At its August 1 meeting, the Fed was expected to keep interest rates unchanged, and that is indeed what occurred. Ahead of the decision, fed funds futures were pricing in a roughly 60% chance of two additional rate hikes by the end of the year.
The European Central Bank (ECB) announced it would continue its asset-buying program through the end of September and stated it would keep interest rates unchanged “at least through the summer of 2019.” Markets moved little on the news.
The Bank of Japan pledged to keep its ultra-easy monetary policy in place for “an extended period of time.” While the market largely expected policy to remain in place in the short term, investors were looking for any sign of a more hawkish approach after reports that tweaks to Japan’s asset purchase program were being considered.
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