Gross domestic product (GDP) advanced at a 3.0-percent annualized pace in the third quarter, a solid performance, especially considering the drag from the disruptions caused by Hurricanes Harvey, Irma and Maria during the period.
This report is definitely a case where it is necessary to dig into the details of the data to get a better sense of where the economy is and where it may be heading.
{mosads}To begin, GDP in the first half of the year averaged a little above 2 percent, roughly in line with the trend that has been in place for most of this expansion. However, the underlying economy actually showed signs of picking up steam.
Firms failed to build inventories in line with the gains they were enjoying in final sales, which meant that inventories dragged down overall growth by about three-quarters of a percentage point.
The main impetus for the acceleration in final demand in the first half of the year was a substantial acceleration in business investment, as firms have become more optimistic, perceiving a more favorable tax and regulatory environment ahead.
With that as context, the economy’s performance in the third quarter reflected a variety of forces. First, disruptions from hurricanes, mainly Harvey and Irma, modestly dampened consumer spending but more substantially held back construction activity.
Consumer spending rebounded surprisingly well in September after a sharp dip in August (in particular, auto sales sagged in August but surged back in September, earlier than expected). In the end, consumer spending in real terms increased at a 2.4-percent annualized clip in Q3, only modestly below recent trends.
In contrast, housing and nonresidential construction both dropped in Q3, as did state and local government construction outlays. The drag from the hurricanes helped to limit the growth in domestic final demand to 1.8 percent, which was the weakest performance since the first quarter of last year (which, ironically, was also held back by weather — in that case, a series of snowstorms).
The strong headline GDP figure was driven instead by an improvement in the trade balance in the quarter and faster inventory accumulation. The former added about half a percentage point to the Q3 growth figure while the latter provided a boost of 0.7 percentage points.
The details with regard to inventories were particularly interesting. As noted above, inventories were close to flat in the first half of the year, which means that, relative to sales, firms’ stocks were getting leaner. An adjustment was inevitable, and, as expected, it began in Q3.
Essentially, inventories closed about half of the gap between the roughly flat Q2 reading and the pace of accumulation needed to keep up with final sales. Thus, there is still room for inventories to accumulate faster without generating an overhang in stocks, which should provide an additional boost to GDP in Q4.
Thus, as we look ahead to the current quarter, there is ample reason to be optimistic that real GDP could grow by 3 percent or better for a third-straight quarter (the last three-quarter string of 3-percent-plus growth occurred in 2004-05).
Consumer spending should post a solid gain, as underlying fundamentals are underpinned by a strong labor market (which is generating robust income increases). Meanwhile, construction activity should bounce back in Q4 and may even surge to an above-trend level as rebuilding in Texas and Florida commence.
Finally, firms are likely to further build up their inventories. Retailers actually shed stocks in Q3, so they should replenish their shelves ahead of what is expected to be a successful Christmas selling season (which means that GDP can be boosted by strong retail sales, a buildup in inventories, or both).
In all, the stage seems to be set for a robust growth performance in the current quarter, which would drive the average for the year above 2.5 percent, suggesting that the economy may finally be accelerating out of its 2-percent rut.
Stephen Stanley is the chief economist for Amherst Pierpont Securities, a broker dealer providing institutional and middle-market clients with access to fixed-income products.