The mid-term elections are 12 days away and the first estimate for September quarterís GDP was released Friday morning, showing growth of 3.5%. This is a decrease from 4.2% in the June quarter but a bit above expectations. To smooth out any one quarterís spike or drop, the U.S. economy grew 3.0% on a trailing four quarter basis, slightly higher than the June quarterís 2.9% metric.
There are at least three major unknowns that will impact the U.S. economy going forward.
How much of the economyís increase is due to tax cuts? And could they be a sugar rush that will wear off? The resulting yearly Federal deficit to $1 trillion (or more starting next year) could have significant negative long-term consequences.
Trumpís tariff wars could impact the economy not just in the short-term but also in the long-term, as countries may adjust their domestic policies if they think the U.S. is not a reliable trading partner. For example, think of China becoming more focused on increasing soybean production and therefore having a long-term impact on U.S. farmers.
The Fed has raised its benchmark interest rate three times this year, it looks like they will do so again in December and potentially three times in 2019. While still at historically low levels, additional raises could impact housing, car purchases and business investments.
Below are a few of those indicators that I think are worth highlighting.
GDP growth helped by inventory growth but hurt by exports
A couple of items from the GDP report to keep in mind. In any given quarter, the major components (personal consumption, private domestic investment, inventory changes and imports & exports) can fluctuate significantly, as they did this quarter. One key swing factor this quarter was inventory growth adding just over 2.1% to the result, but this was largely offset by exports subtracting 1.7%. Government spending also added 0.6% to GDP growth, which is the highest result since the first quarter of 2016. When these components are removed GDP growth would have been 2.7%, down from 3.7% in the June quarter.
Job growth continues its five year trend
The economy is on pace to add 2.5 million jobs this year, above 2016 and 2017 figures but below 2014 and 2015. It could be difficult to exceed 2015ís 2.71 million due to the challenges companies have finding people with the right skills. Additionally, the administrationís tightening immigration policy could put a damper on not just having enough people for organizations to hire, but also having people with the right talents and expertise.
The S&P 500 is being buffeted by tariffs and higher interest rates
As of Friday morning, the S&P 500 is up 23% since Trump was elected but has fallen 9% over the past three months and is now down about 1% for the year. While earnings have increased about 20% this year, driven by the corporate tax cuts, concerns about lower earnings growth next year, tariff wars and increased interest rates have put the stock market on a roller coaster.
Plan for the 10 year Treasury interest rate to continue to increase
The Federal Reserve has raised its target interest rate three times this year to a range of 2% to 2.25% and looks to step it up to 2.25% to 2.5% in December. This has helped push up the 10 year Treasury rate from under 2.5% during 2017 to 3.14% as of Thursday. If the Fed follows through with another three increases in 2019, putting its target rate at 3.0% to 3.25% the 10 year could easily move above 3.5% and approach 4%, especially if the Federal deficit crosses $1 trillion in a growing economy.
Core CPI remains above 2%
The Consumer Price Index, or CPI, has moved above the Fedís 2% target. The all items CPI has pulled back from a 2.9% increase in June to 2.3% year over year in September. When food and energy are removed, since they can be volatile, the Core CPI in August and September was a 2.2% rate. If Core CPI remains above 2%, this is another reason that the Fed will continue to increase interest rates.
Federal deficit shooting above $1 trillion a year
The federal deficit peaked at $1.4 trillion in 2009 due to the Great Recession and fell to a low of $438 billion in 2015. It increased to $666 billion in fiscal 2017 (Obamaís last budget), but due to the Republican and Trumpís tax cuts it looks to hit $1 trillion in fiscal 2019 after coming in at $779 billion in fiscal 2018. Unless the economy can consistently generate 3% or greater growth the deficits will likely remain above $1 trillion. This is a tall order because the economy should slow or contract (historically we are overdue for this) and the deficit will balloon even higher.
U.S. trade deficit has increased under Trumpís watch
After hovering around $500 billion during the last three years of Obamaís presidency, it rose to $552 billion in 2017 and was $583 billion over the past twelve months. While Trump rails on trade, the larger deficit is being driven by the strength of the U.S. economy (a good thing). He is correct that certain industries and citizens are negatively impacted by other countries trade practices. However, he overlooks that U.S. consumerís benefit from products being sourced from other countries.