FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
October 31, 2017

1. How the US Economy Can Sustain 3% Growth

2. The Economy Was Stronger Than Expected in the 3Q

3. New Home Sales Surged to 10-Year High in September

4. September Durable Goods Orders Up 8.3% Over Last Year

5. How 3% Growth Affects the Fed’s Rate Hike Thinking

How the US Economy Can Sustain 3% Growth

The US economy just turned in its second consecutive quarter of 3% growth in Gross Domestic Product, to the surprise of most forecasters and the mainstream media. This despite the negative effects of two major hurricanes hitting the southern US late this summer.

With hurricane rebuilding efforts underway in Texas, Louisiana and Florida, retail sales, industrial production and other indicators are already showing acceleration. This suggests we could see another quarter of 3% growth or better for the final three months of this year.

The Conference Board’s Consumer Confidence Index, the Investor’s Business Daily/TIPP Economic Optimism Index, the National Association of Manufacturers survey and the Institute for Supply Management Index all report stronger optimism and rising factory output. Overall optimism hasn't been this high in over a decade.

The current unemployment rate at 4.2% is the lowest since before the financial crisis. Total employment has jumped more than 2.2 million since Trump entered office. Even the broadest US unemployment measure, the so-called U-6, now stands at 8.3% – its lowest level since June of 2007 before the Great Recession.

Meanwhile, all the major stock market indexes are hitting record high after record high, with the Dow Jones Industrial Average topping 23,000 for the first time this month – up over 30% since last November. The stock market is generally a reliable (but not perfect) predictor of future economic activity. Its message today is clear: Expect more growth.

The question is whether 3% or higher growth is sustainable, and I believe it is. I think it will be even more likely if Congress passes meaningful tax reform just ahead, which is looking more likely now that a (bloated) federal budget has been passed.

Friends and colleagues are asking me why the economy has shifted into a higher gear. As I have written here in recent weeks, I believe the national mentality has undergone a major shift to the optimistic side. A big reason for this is the change in leadership last November.

Whether you like President Trump or not, he has embarked on one of the most sweeping deregulation campaigns in recent presidential history. He got rid of President Obama's disastrous "Clean Power Plan" and walked away from the growth-killing “Paris Climate Accord.”

He's also removing oil and gas drilling restrictions on numerous federal lands. Along with the fracking revolution, this will make the US a global energy powerhouse in the years ahead. Natural gas production has already increased to the point that we are now a net exporter for the first time in decades.

The result of all this deregulation is that tens of billions of dollars of dead weight have been lifted from the economy's shoulders, virtually overnight. Trump's nine months in office have been marked by pro-growth policies overall that will increase investment, boost jobs and lead to higher economic growth.

This is happening even before we get tax reform that will lower tax rates for corporations, entrepreneurs and the middle class, bringing an estimated $1.5 trillion in tax relief. That will encourage more companies to invest in plants, equipment and training and to hire more workers. So things could get even better.

Of course, if the Republicans blow it and fail to pass meaningful tax reform, that’s a game-changer. Absent that, I believe the current economic momentum is sustainable.

Now let’s take a look at the latest encouraging economic news.

The Economy Was Stronger Than Expected in 3Q

The US economy unexpectedly maintained a brisk pace of growth in the 3Q as an increase in inventory investment and a smaller trade deficit offset the hurricane-related slowdown in consumer spending and a temporary decline in construction.

Gross Domestic Product increased at a 3.0% annual rate in the July-September quarter after expanding at a 3.1% pace in the 2Q, the Commerce Department said on Friday. That was well above the pre-report consensus of 2.5%.

The Commerce Department said it was impossible to estimate the ultimate impact of hurricanes Harvey and Irma on 3Q GDP. Yet preliminary estimates indicate that the back-to-back storms caused losses of $121.0 billion in privately-owned fixed assets and $10.4 billion in government-owned fixed assets.

Hurricanes Harvey and Irma hurt incomes and crimped consumer spending in the 3Q, especially in Texas and Florida. Growth in consumer spending, which accounts for more than two-thirds of the US economy, slowed to a 2.4% growth rate in the 3Q following a robust 3.3% pace in the 2Q.

Businesses accumulated inventories at a strong $35.8 billion pace in the 3Q in anticipation of rising demand. As a result, inventory investment contributed 0.73% to 3Q GDP growth, after adding just over 0.1% to growth in the prior quarter. It remains to be seen, of course, if inventory rebuilding will be as strong in the 4Q.

Exports increased at a 2.3% rate in the 3Q, while imports fell at a 0.8% pace. That left a smaller trade deficit, leading to trade adding 0.41% to GDP growth. Trade has contributed positively to GDP for three quarters in a row.

With hurricane rebuilding efforts underway in Texas, Louisiana and Florida, retail sales and industrial production are already showing acceleration. This suggests we could see another quarter of 3% or better growth in the final three months of this year.

New Home Sales Surged to a 10-Year High in September

In a huge surprise, US new home sales in September recorded the largest single-month percentage increase since 1992, a sign the market remains resilient despite two major hurricanes and a continuing inventory shortage of homes.

Purchases of newly built single-family homes swelled 18.9% in September, far above expectations. The actual number of new homes sold climbed to a seasonally adjusted annual rate of 667,000 units in September, the Commerce Department said last week. That put new home sales at the highest level since October 2007 and well above the pre-report consensus of just 555,000 units.

Both new and existing home sales had been weak through much of the spring and summer, as a shortage of inventory and rising prices have kept many would-be buyers out of the market. Last week’s report suggests that trend has reversed. For the year to date, new home sales are 8.6% higher compared to the same period last year.

The report was greeted with widespread surprise by economists, most of whom expected modest declines in sales in September due to hurricanes in Florida and Texas. Yet sales rebounded much sooner than expected following a storm-soaked August. They were up strongly in every region, including in the South, which was battered by hurricanes. In Texas and Florida, new homes sales surged by a whopping 25.8% last month.

In September, the median home sales price was $319,700, compared to $314,700 a year ago and up 5.2% from August. At the current sales pace, it would take just five months to exhaust all available supply. Many more homes are needed in this market that is starved for inventory.

Economists cautioned that continued rising home prices could begin to put a damper on the market in the months ahead. Yet for now, strong demand and limited supply have helped push prices up, and rising labor and material costs due to hurricane recovery efforts are likely to exacerbate the trend.

“At some point housing affordability will become a larger issue,” said Rob Dietz, chief economist at the National Association of Home Builders.

Builders reported on their most recent earnings calls that they already are beginning to see shortages of workers and materials such as sheetrock. They are attempting to control costs by stockpiling materials and leaning on longstanding relationships with contractors.

New-home sales data can be volatile and subject to revision. Thus, the huge September increase could be revised down in the months ahead. Even so, it is a huge number that no one expected.

Sales of existing homes, which represent the bulk of the US market, rose only 0.7% in September from a month earlier to a seasonally adjusted annual rate of 5.39 million units, the National Association of Realtors said last week.

September Durable Goods Orders Up 8.3% Over Last Year

Robust demand for long-lasting US factory goods suggests business investment is strengthening, contributing to broader economic growth. New orders for durable goods rose a seasonally adjusted 2.2% in September from a month earlier, the Commerce Department reported last week. For the 12 months ended September, durable goods orders were up 8.3%.

Consumer durable goods are products designed to last at least three years, such as appliances, furniture, jewelry, autos, auto parts, firearms, tools, garden equipment, medical devices, etc.

The rise in September more than doubled economists’ expectations for a 0.8% increase and marked the second month in a row of higher orders following a gain of 2.0% in August. This means that manufacturers in the US headed into the 4Q on a strong footing. Orders are a closely-watched leading indicator of economic activity.

In both August and September, orders were boosted by large increases in the extremely volatile civilian-aircraft category. Wednesday’s report offered evidence that underlying business investment, beyond aircraft, is also robust.

Manufacturing has been improving since the middle of 2016, following a two-year slump caused by cutbacks in the energy industry and a strong dollar that made US goods costlier overseas. Prospects are brighter now with the dollar weakening in value this year, which makes US exports more competitive in overseas markets, and a rebound in energy drilling.

How 3% Growth Affects the Fed’s Rate Hike Thinking

The Fed has made it clear for several months that it wants to raise the Fed Funds rate a third time before the end of the year. This intention was in place well before last week’s surprise 3% increase in 3Q GDP. That good news should make a third rate hike this year a slam dunk.

The Fed Open Market Committee (FOMC) is meeting today and tomorrow, but a rate hike is not expected at this meeting. The most likely time for the final rate hike of this year will be at the December 12-13 meeting. The current Fed Funds target range is 1.0%-1.25%, and that will likely be lifted to 1.25%-1.50% at the December meeting.

The White House suggested late last week that President Trump will announce his choice for head of the Federal Reserve this week, most likely on Thursday we’re told. I wrote about the leading contenders in these pages last week, and it seems little has changed.

If correct, the leading contenders remain (in no particular order): current Fed Chair Janet Yellen, current Fed Governor Jerome Powell, Stanford University economist John Taylor and former Fed Governor Kevin Warsh.  Unnamed White House sources said over the weekend that President Trump is leaning toward Jerome Powell, a Republican, for the top slot at the Fed. It will be interesting to see who gets the nod.

Wishing you a spooky Halloween,

Gary D. Halbert

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