U.S. MarketFlash | Economic Watch: GDP Growth Accelerates in Q2
July 28, 2017
Executive Summary: Gross Domestic Product (GDP) for Q2 2017 grew by 2.6% at an annualized rate, in line with consensus expectations. This was the best quarter since Q3 2016 when growth was 2.8%. By comparison, growth in the second quarter last year was 2.2% and in Q2 2015 was 2.7%.
Fed Watch: The Fed’s outlook and expected path will not be affected by this report. Growth is still on track to reach between 2% and 2.25% this year. The bigger concern for the Fed is inflation. The most recent inflation numbers have been falling below the Fed’s 2% target. We still expect the Fed to raise the federal funds rate once more in 2017, although futures markets have been lowering that probability recently. The more important factor is that the Fed has signaled that it will unwind its balance sheet soon, likely beginning in September. This will impact the long end of the yield curve much more than the federal funds rate. To date, the Fed’s actions have had minimal impact on the long end of the curve, and yields have flattened over the past four months.
Goodbye LIBOR: The U.K. Financial Conduct Authority announced yesterday that LIBOR, the long-time global interest rate benchmark, will be eliminated by 2021. CBRE Research and Capital Markets professionals conclude that although the banking and securities industries have relied on LIBOR for the past 50 years to determine short-term interest rates, its elimination will have little impact on the cost of borrowing. See our separate MarketFlash report on this today.
Policy Implications: After a run-up following the Trump inauguration, 10-year Treasury yields have settled at 2.3%, as the market started to discount forecast economic growth. That is down from 2.6% in March, and the 10-year Treasury inflation-protected security (TIPS) is now virtually unchanged since the U.S. presidential election last November. The bond market is signaling that its optimism is waning due to the slower-than-expected policy rollouts of the Trump administration and the failure to pass health care reform. Given the failure of the health care bill last night, Congress has signaled that it is prepared to move on to tax reform while figuring out the next steps for health care. Passing meaningful tax reform will be critical to sustaining optimism, but that appears unlikely in 2017.
Tax Reform: The plan announced earlier this week by Treasury Secretary Steven Mnuchin and National Economic Director Gary Cohn had few surprises and limited detail. The biggest news was the removal of the boarder adjustment tax from the proposal. Retailers were pushing hard for the removal of that proposal. The joint statement specified that the mission of the tax reform bill was to “protect American jobs and make taxes simpler, fairer and lower for hard-working American families.” No additional details were given.
Consumer Spending: Consumer spending rebounded from a sluggish Q1 to 2.8% annualized growth in Q2. This is a similar pace to the second half of 2016. Spending on durable goods rose 6.3% after falling in Q1. Most of the goods subcategories were positive contributors to GDP.
Capital Investment: Business investment grew by 5.2%, the second-fastest growth in the past 12 quarters. Spending on equipment rose 8.2%—that segment’s highest growth rate in two years.
Imports/Exports: Aided by the weak dollar, exports rose by 4.1%, while imports increased only 2.1%. Trade was a positive contributor to GDP for the second consecutive quarter at 0.2% in Q2.
Government Spending: After subtracting from growth in Q1, government spending added to the economy in Q2. Federal defense spending led to the gain. Should the administration pass an infrastructure program, this contribution would increase.
Residential Investment: Residential investment declined by nearly 7% in Q2. This is likely a seasonal reaction to the strong first-quarter growth.
Autos: For the second consecutive quarter, the Motor Vehicles & Parts sector was a negative contributor to growth. The auto industry will likely continue to weaken due to excess supply and falling demand. If so, this will subtract from growth for the remainder of the year.
Retail: Retail sales remain strong and this GDP report had a lot of positive news. Combined with the death of the boarder adjustment tax, retail has had a good week. There are still challenges facing the industry, but strong consumption patterns and rising wages should help retail as it adjusts to the new market paradigm.
Office: Job growth has maintained a hiring pace similar to 2016 in the first half of the year, but that is likely to slow in the second half. Despite the healthy pace of hiring, firms are still taking longer to make leasing decisions.
Industrial: The rise in exports is good for the economy, but doesn’t help the industrial market as much as imports. Imports use three times the space exports do and import growth has slowed. There are other tailwinds keeping the industrial market strong, but a continued rise of exports and slowing of imports is something that could hurt the industrial market.
Multifamily: Demand for apartments remains strong, but supply has gotten ahead of demand for Class A units. Rent growth is still positive for 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.