Executive Summary: Gross Domestic Product (GDP) grew at an annualized rate of 3.0% in Q3 2017, surpassing the 2.5% consensus estimate. This was the best third quarter since Q3 2014—when growth was 5.2%—and it was only the third time that growth has reached 3% or higher in the past 12 quarters.
Fed Watch: The Fed’s outlook and expected path will not be affected by this report. We still expect one additional rate hike in December. The Fed began slowly unwinding its balance sheet in October. GDP growth is still on track to reach 2.25% for the year, which is the high end of our forecast range (2%-2.25%). The Fed remains concerned about low inflation, though there was an increase in the Consumer Price Index in Q3 due to the impact of hurricanes Irma and Harvey.
Policy Implications: The 10-year Treasury yield has risen significantly over the past two months, as stronger economic growth changed investor expectations. After reaching a low of 2.05% on September 7, the 10-year is now trading around 2.45%. That is still below the 2.6% from last March, but the current yield is the highest it has been since that time.
Tax Reform: The House of Representatives passed the previously approved Senate budget blueprint last night. This allows for a tax reform bill to pass with 51 votes via the budget reconciliation process and provides an easier path to tax reform. Two major issues—state and local tax deductibility and potential limits on pre-tax contributions to 401(k) accounts—must be reconciled by the Republican caucus for any tax reform bill to move forward. The treatment of interest deductions and other real estate-related issues are still subject to debate.
Consumer Spending: Although consumer spending growth dropped to 2.4% in Q3 from 3.3% in Q2, it was still above consensus expectations given the disruptions from recent hurricanes. Spending on durable goods rose by 8.3% in Q3 from 7.6% growth in Q2. Most of the goods subcategories were positive contributors to GDP.
Business Equipment Investment: Business equipment investment grew by 8.6% in Q3 after an 8.8% increase in Q2—the strongest growth this sector has seen since early 2014. This type of investment should increase productivity, which should help future GDP growth.
Imports/Exports: Aided by the weak dollar, exports rose by 2.3% in Q3, while imports fell 0.8%. Trade was a positive contributor to GDP (0.41 percentage points) for the third consecutive quarter.
Private inventory growth added 0.7 percentage points to GDP growth. This growth can be interpreted in different ways. Some will view it as stealing from the future, since businesses will need to sell that inventory before ordering more. A more optimistic view is that businesses have an increasing confidence in future economic growth.
Structures: Residential investment declined by 6.0% in Q3 after falling by 7.3% in Q2. Investment in non-residential structures also fell (-5.2%).
State & Local Government: Spending by state and local governments declined by 7.1%.
Real Disposable Income: Real personal disposable income rose by 0.6%, a minimal rate that is not a good sign for future consumption growth.
Savings: The savings rate fell to a decade-low 3.4%
Retail: Retail sales remain strong and this GDP report had a lot of positive news. The tight labor market is finally leading to increased wage growth, which will help retailers. Nevertheless, e-commerce continues to grab a greater share of those retail sales. Retail centers that are well located, have strong tenants that understand the new paradigm and continue to evolve will do well. The removal of older, weaker centers will only enhance those that remain.
Office: Job growth continues to slow, although September’s job number was impacted by recent hurricanes. A better reading of the job market will come next Friday when October’s job report is released.
Industrial: The rise in exports is good for the economy, but doesn’t help the industrial market as much as imports. Imports use three times the space that exports do and import growth has slowed. There are other tailwinds keeping the industrial market strong, but a continued rise of exports and slowing of imports is something that could hurt the industrial market.
Multifamily: Demand for apartments remains strong, but supply has gotten ahead of demand for Class A units. Rent growth remains positive for B/C units, but Class A rent growth has stalled. Solid economic growth should help renters’ pocketbooks and their ability to pay more. Rising wages could lead to a move up in quality and allow some of the luxury overhang to burn off.