GDP rises 2.6% in Q4; trade & inventory weigh down growth
Jan 26, 2018, 13:15 PM
Executive Summary: Gross Domestic Product (GDP) grew at an annualized rate of 2.6% in Q4—slower than the 3.2% registered in Q3 and below the 3.0% consensus estimate. The weaker-than-expected pace of growth reflected a drag from net exports and inventories that somewhat offset the strength in consumer spending. Government spending rose 3%, amid post-hurricane rebuilding efforts. For the year, GDP grew by 2.3% in 2017, up from 1.5% in 2016.
Fed Watch: The Fed’s outlook and expected path is unlikely to be affected by this report. Although the Fed has penciled in three rate hikes for 2018, any increase in concern over fiscal policy (i.e., tax reform) and its effect on inflation will likely be reflected in the Fed’s projections.
Policy Implications: Tax reform may drive down the unemployment rate to as low as 3%, as private investment may increase and thus lead to further job creation and wage growth. On the other hand, productivity may continue to grow and the labor force participation rate could increase. We think that inflation will gently pick up and the risks are moderately to the upside. Likewise, stronger investor sentiment—driven in part by the strong jobs data, a modest uptick in wages and expectations about future growth and inflation—has driven up the 10-year Treasury yield to 2.64% from 2.4% so far this year, its highest level since December 2016.
Tax Reform: The recently enacted $1.5 trillion tax-cut package, which includes a sharp reduction in the corporate income tax rate to 21% from 35%, should boost the job market. However, gains will likely be modest given that the timing of the stimulus coincides with the economy operating almost at full capacity.
Consumer Spending: Consumer spending grew by 3.8% in Q4—the quickest pace in three years—from 2.2% in Q2. Spending on durable goods rose by 14.2% in Q4 from 8.6% growth in Q3. Rising household wealth due to the stock market rally, higher house prices, tax cuts and an uptick in wage growth will continue to support consumer spending going forward.
Business Equipment Investment: Business equipment investment grew by 11.4% in Q4—the quickest pace since Q3 2014—after a 10.8% increase in Q3. The cut in corporate income taxes and the recent gains in crude oil prices should further spur spending on business equipment.
Residential Fixed Investment: Investment in homebuilding accelerated to 11.6% in Q4 after two consecutive quarters of contraction.
Exports: Aided by the weak dollar, exports of goods rose by 12.6% in Q4 from 1.8% in Q3, thus contributing positively to overall GDP growth.
Imports: Imports of goods grew by 16.8% in Q4 after contracting by 0.2% in Q3. The sharp acceleration in imports subtracted 0.96 percentage points from overall GDP growth.
Inventory: Inventory investment also restrained GDP growth in Q4, subtracting 0.67 percentage points, after adding 0.79 in Q3.
Savings: The savings rate fell to a decade-low of 2.6%, compared to the previous low of 3.3% in Q3 2017.
Retail: Retail sales remain strong and this GDP report—particularly on the consumer spending front—bodes well for the retail sector. 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 retail sales. Well-located retail centers with strong tenants understand this new paradigm and will continue to do well. The removal of older, weaker centers will only enhance those that remain.
Office: With the economy operating at or near capacity, employers will find it difficult to fill skilled positions from the current workforce. While a rise in participation would help, growth of the labor force will be limited due to the aging population. Likewise, the tax cuts might boost the job market, but gains will likely be modest given that the timing of the stimulus coincides with the economy operating almost at full capacity.
Industrial: While the increase in exports is good for the economy, the sharp acceleration in imported goods augurs well for the industrial sector since imports use three times the space that exports do.
Multifamily: Demand for apartments remains strong, but supply has gotten ahead of demand for Class A units. Rent growth remains positive for Class 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.