Economic Overview – Third Quarter 2018
During the second quarter of 2018, the U.S. economy grew at a feverish 4.2% over the prior quarter. Economic indicators point toward continued economic growth.
Overview of the U.S. Economy
According to the third estimate released by the Bureau of Economic Analysis (BEA), the U.S. economy grew in the second quarter of 2018, with real gross domestic product (GDP) increasing at an annual rate of 4.2%, following a first quarter 2018 increase of 2.2%. The increase in real GDP in the first quarter reflected positive contributions from nonresidential fixed investment, PCE, exports, federal government spending, and state and local government spending that were partly offset by the negative effects from residential fixed investment and private inventory investment.1 This brings the US economy its seventeenth consecutive quarter with positive GDP growth. For comparison, the longest streak of consecutive quarters is thirty-nine, which occurred between 1991 and 2001.
Forecasters surveyed by the Federal Reserve Bank of Philadelphia predicted, on average, a 3.0% annual real growth rate for the third quarter of 2018 and 2.8% for the fourth. The forecasters predicted, on average, that real GDP will grow 2.8% in 2018, 2.8% in 2019, 1.8% in 2020, and 1.5% in 2021. The forecast for 2019 is higher than previous estimates, while the forecasts for 2020 and 2021 are lower than previous estimates for the same periods.2
Population growth is an important driver of long-term growth in an economy. The total population increased from 326.3 million in August 2017 to 328.6 million in August 2018. The working age population (15-64) increased from 205.6 million in August 2017 to 206.6 million in September 2018. The elderly population (65+) increased from approximately 50.3 million in August 2017 to 50.6 million in August 2018.
The labor force participation rate has not budged in recent years and remains lower than pre-2008 levels. In August 2018, the civilian labor force participation rate was 62.7%. The minimum participation rate in the past decade was 62.3%, recorded in September 2015, while the maximum of 66.4% was recorded in December 2006. This is at least partially explained by the aging population but could be evidence of slack in the labor force.
Nonfarm payroll employment, according to the Bureau of Labor Statistics (BLS), rose by 201,000 in August 2018. The unemployment rate (U3) in August 2018 was unchanged at 3.9%. The BLS reported job gains in professional and business services, health care, wholesale trade, transportation and warehousing, and mining.3 This is slightly below the Federal Open Market Committee (FOMC) participants’ projections of the long-run natural rate of unemployment, which have a range of 4.0 to 4.6%.
Forecasters surveyed by the Federal Reserve Bank of Philadelphia predicted, on average, that the unemployment rate will be 3.9% in 2018, 3.6% in 2019, 3.7% in 2020, and 4.0% in 2021.4
The U6 unemployment rate, which includes all marginally attached workers and those employed part-time for economic reasons, has declined from 8.6% in August 2017 to 7.4% in August 2018. The gap between U3 and U6 has declined from the 10-year high of 7.4% in September 2011 to 3.5% in August 2018.
The average number of weeks unemployed has declined to near pre-2008 levels, to 22.6 weeks in August 2018, from 24.3 in August 2017. This is far below the 10-year high of 40.7 weeks in July 2011, and slightly above the 16.5 weeks in March 2008. The number of jobless claims has also been declining. For the week ending September 22, the number of seasonally adjusted jobless claims was 214,000, while for the prior year that number was 258,000.5
According to the BLS, inflation, as measured by changes in the Consumer Price Index for All Urban Consumers (CPI-U), increased 0.2% in August 2018 on a seasonally adjusted basis. Over the previous 12 months, the all items index increased 2.7% before seasonal adjustment. The index for all items less food and energy rose 2.2% for the twelve-month period ending August 2018. The energy index rose 10.2% over the last year, while the food index increased 1.4%.6 The price pressures measure measures the probability that the personal consumption expenditures price index inflation rate will exceed 2.5% over the next twelve months. This price pressures measure reported a probability of 2.98% in September 2018, which is reasonably low relative to the past five years.7
Forecasters surveyed by the Federal Reserve Bank of Philadelphia predicted, on average, headline CPI inflation to be 2.4% in 2018, 2.3% in 2019, and 2.3% in 2020. Over the next ten years, forecasters expect CPI inflation to average 2.20% annually.8
The interest rate on the three-month Treasury bill increased from 1.04% as of September 29, 2017 to 2.15% as of September 28, 2018.9 The interest rate on the ten-year Treasury note increased from 2.33% as of September 29, 2017 to 3.05% as of September 28, 2018.10
On September 26, 2018 the FOMC announced their decision to increase in federal funds target range from 1.75 – 2.0% to 2.0 – 2.25%. This increase was anticipated, and the FOMC also removed the following sentence from their official statement:
The stance of monetary policy remains accommodative, thereby supporting strong labor market conditions and a sustained return to 2 percent inflation.11
The following charts display projections from FOMC officials of the federal funds rate path, as well as the implied projections from federal funds rate futures markets. 12, 13
President Trump has expressed concern regarding the FOMC’s decisions to increase rates, and following the September 26, 2018 meeting, he said, “Unfortunately, they just raised interest rates, I am not happy about that.”14 The following table below represents the market’s reaction during the lead up to and following the FOMC meeting.
As of September 28, 2018, the yields on Moody’s Aaa-rated corporate bonds and Baa-rated corporate bonds were 3.99% and 4.89%, respectively.15
The spread between the twenty-year and the one-year treasury bills declined from 1.32% as of September 29, 2017 to 0.54% as of September 28, 2018.16 A combination of increasing short-term interest rates from federal funds rate hikes and tempered long-term growth expectations have caused the yield curve to flatten in recent years. The spread between long- and short-maturity Treasury securities have long been used as a predictive measure for future economic performance. A recent paper from the Federal Reserve showed that the probability of a near-term recession has increased in recent years.17 However, when additional information was incorporated into their model, such as the excess bond premium,18 the component of corporate bond spreads in excess of an estimate of the compensation for expected default losses, the recession probability was significantly lower.
According to the BEA, profits from current production (corporate profits with inventory valuation and capital consumption adjustments) increased $65.0 billion in the second quarter of 2018 over the first, compared to an increase of $26.7 billion in the first quarter of 2018 over the fourth quarter of 2017.19
The S&P 500 Total Return20 Index opened at 4,387.96 on September 30, 2017 and closed higher at 5,144.09 on September 30, 2018. This corresponds to an annual return of 17.2%. The Dow Jones Industrial Average Total Return Index opened at 48,051.36 on September 30, 2017 and closed higher at 58,028.52 on September 30, 2018. This corresponds to an annual return of 20.8%. The NASDAQ Composite Total Return Index opened at 7,447.57 on September 30, 2017 and closed higher at 9,322.12 on September 30, 2018.21 This corresponds to an annual return of 25.2%. In the graph below, the June 30, 2017 values were set to 100. Each of these indices is near their all-time highs.
Construction & Housing Starts
Construction spending and housing starts are two other important indicators for the economy. Construction spending may indicate the sentiment in real estate markets and the soundness of the economy, while housing starts are an alternative indicator of consumer sentiment. Increases in demand for newly-constructed homes can lead to job growth in the construction industry, increased demand for appliances and furniture, and can have a ripple effect throughout the economy. Housing starts increased from 1,185 thousand units in July 2017 to 1,174 thousand units in July 2018.22 Construction spending, a seasonally adjusted annual rate, increased from $1,242,806 million in July 2017 to $1,315,441 million in July 2018.23
The Conference Board reported that the Consumer Confidence Index increased in September 2018 to 138.4, up from 134.7 in August 2018.24 The index is based on a survey of consumer perceptions of present economic conditions and expectations of future conditions. The survey is based on a representative sample of 5,000 U.S. households and is considered a leading indicator of future consumer expenditures and economic activity.
The University of Michigan Survey of Consumers reported that the Index of Consumer Sentiment increased in September 2018 to 100.1, up from 96.2 in August 2018 and 95.1 in September 2017.25 The index is based on a survey of consumer perceptions of present economic conditions and expectations of future conditions. The survey is based on a sample of 500 phone interviews consisting of 50 core questions are conducted across the continental U.S. This is considered a leading indicator of future consumer expenditures and economic activity.
According to Surveys of Consumers chief economist, Richard Curtin, the primary driver for the September gain was among households with incomes in the bottom third, whose index value was the highest since November 2000. On the contrary, the index for households with incomes in the top third fell 8.1% during the past seven months. Concerns over the negative impacts of tariffs were cited by nearly one-third of all consumers in September.
In conclusion, the economy continued to perform well in the second quarter of 2018. Economic growth exceeded expectations, reaching over 4% annualized growth for the first time since quarter three of 2014. Inflation has been modest while unemployment remains low, hovering around FOMC participants’ projections of the natural rate of unemployment. Equities markets have been performing exceptionally well, near all-time highs, and both consumer and investor sentiment remains optimistic. Threats to the economy include potential ramifications from rising tariffs, the impact of the Federal Reserve’s decision to increase the federal funds rate, and political instability as we approach the midterm elections.
The following table displays a summary of the economic indicators, their performance over the past year, and whether this is viewed as a positive or negative sign for the economy at large. The leading, lagging, and coincident indices were obtained from The Conference Board.
1. U.S. Department of Commerce, Bureau of Economic Analysis, Gross Domestic Product: Second Quarter 2018 (Third Estimate), September 27, 2018
2. Federal Reserve Bank of Philadelphia, Third Quarter 2018 Survey of Professional Forecasters, August 10, 2018
3. United States Department of Labor, Bureau of Labor Statistics, The Employment Situation: August 2018, September 7, 2018
4. Federal Reserve Bank of Philadelphia, Second Quarter 2018 Survey of Professional Forecasters, August 10, 2018
5. United States Department of Labor, Bureau of Labor Statistics, Unemployment Insurance Weekly Claims, September 27, 2018
6. United States Department of Labor, Bureau of Labor Statistics, Consumer Price Index: August 2018, September 13, 2018
7. Federal Reserve Bank of St. Louis, Federal Reserve Economic Data, Series: STLPPM, Price Pressures Measure, last accessed October 1, 2018
8. Federal Reserve Bank of Philadelphia, Third Quarter 2018 Survey of Professional Forecasters, August 10, 2018
9. Federal Reserve Bank of St. Louis, Federal Reserve Economic Data, Series: DTB3MS, 3-Month Treasury Bill: Secondary Market Rate, last accessed October 1, 2018
10. Federal Reserve Bank of St. Louis, Federal Reserve Economic Data, Series: DGS10, 10-Year Treasury Constant Maturity Rate, last accessed October 1, 2018
11. Wall Street Journal, Fed Statement Tracker, https://projects.wsj.com/fed-statement-tracker-embed/
12. Federal Open Market Committee, Summary of Economic Projections, September 26, 2018
13. Federal Reserve Bank of Atlanta, Market Probability Tracker, last accessed September 27, 2018
14. USA Today, “Why Trump’s Fed-bashing is bad for the economy,” September 26, 2018
15. Federal Reserve Bank of St. Louis, Federal Reserve Economic Data, Series: DAAA, Moody’s Seasoned Aaa Corporate Bond Yield©, Series: DBAA, Moody’s Seasoned Baa Corporate Bond Yield©, last accessed October 1, 2018
16. U.S. Department of the Treasury, Daily Treasury Yield Curve Rates, last accessed October 1, 2018
17. Johansson, Peter, and Andrew Meldrum (2018). “Predicting Recession Probabilities Using the Slope of the Yield Curve,” FEDS Notes. Washington: Board of Governors of the Federal Reserve System, March 1, 2018, https://doi.org/10.17016/2380-7172.2146
18. Gilchrist, S., and E. Zakrajšek (2012), “Credit Spreads and Business Cycle Fluctuations,” American Economic Review 102(4), pp. 1692-1720
19. U.S. Department of Commerce, Bureau of Economic Analysis, Corporate Profits: Second Quarter 2018, September 27, 2018
20. Total return indices include returns from both income and capital gains
21. S&P Capital IQ Database, last accessed October 1, 2018
22. Federal Reserve Bank of St. Louis, Federal Reserve Economic Data, Series: HOUST, Housing Starts, last accessed October 1, 2018
23. Federal Reserve Bank of St. Louis, Federal Reserve Economic Data, Series: TTLCONS, Total Construction Spending, Seasonally Adjusted Annual Rate, last accessed October 1, 2018
24. The Conference Board, Consumer Confidence Index, September 25, 2018
25. University of Michigan, Surveys of Consumers, September 2018
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