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Economic Outlook

Zacks Equity Research

Econ Outlook: Strong GDP Growth in Q3


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The following is an excerpt from our most recent Economic Outlook report. To access the full PDF, click here.

We revised up our near-term outlook for growth on the recent strength of consumer spending and some better-than-expected news on business fixed investment. This, along with a healthy rise in inventory investment, is expected to push third-quarter growth all the way to 3.3% and second-half growth to 2.8%.

Thereafter, growth is expected to ebb to 2¼% in 2017, and roughly 2% in 2018. Of course, growth of personal consumption expenditures (PCE) of over 3%, as expected in the second half of this year, is unsustainable. As it slows to 2.1% in 2017, GDP decelerates; that slowing, however, is mitigated by expected accelerations of both residential and nonresidential investment, which together would contribute 1.1 percentage points to growth in 2017, versus nothing in 2016.

Given the slow growth in potential output, we estimate of around 1¾%, we expect the unemployment rate to drift down to 4.2% by late 2017. That further tightening in labor markets, and the “gravitational pull” of inflation expectations around 2%, suggest core PCE inflation will continue to trend towards 2% through 2018.  

For a variety of reasons, low inflation among them, we expect only one rate hike this year, with December the best bet. Long-term yields fell sharply after the Brexit referendum, but are expected to trend higher through 2018. Equities, boosted by the recent decline in rates, recovered sharply from a brief post-Brexit swoon, but will eke out only small gains from here through 2018.

Sharp pick-up in GDP growth expected in second-half.

  • BEA’s second estimate of Q2 GDP growth came in at 1.1%, and revised data show GDP grew at just a 1% rate over the 1st half of the year and 1.2% in the year through Q2.
  • GDP growth was sharply restrained in Q2 by a surprising outright decline in inventory investment, which we expect will reverse, contributing ½ percentage point to GDP growth over the second half.
  • Final sales to domestic purchasers are projected to grow 2½% over the second half, boosted by continued strength in PCE and pushing GDP growth then to 2.8%.

Little change in the GDP growth profile over 2017-2018.

  • Growth of final sales to domestic purchasers is expected to average roughly 2.6% over 2017-18.
  • A strong dollar and sluggish foreign growth will generate a persistent drag from net exports that subtracts roughly 0.3% pt. from GDP growth over 2017-18.   
  • Within final sales, fundamentals of strong employment, wages, and wealth will support solid growth of PCE expected to average 3% in 2016, and 2.2% in 2017-2018.
  • Nonresidential fixed investment will accelerate as the drop in oil field investments ends and as TFP accelerates.
  • Residential investment will regain momentum, aided by a rise in starts and an end to the decline in the value per unit.

Inflation to reach Fed’s 2% target by early 2018.

  • Core PCE inflation hit 2.1% in Q1 but, as expected, has receded to 1.3% in Q3; we expect 1.7% for the year.
  • Nevertheless, core inflation is expected to resume an upward trend as the effects of the recent rise in the dollar and drop in oil prices wane and as inflation expectations, anchored near 2%, pull inflation higher.

Same Fed policy; little change in financial conditions.

  • Despite an expected rise over the second half, GDP growth has been disappointing, core inflation remains below the Fed’s 2% objective, and global uncertainties persist.
  • This, as well as policy asymmetry, uncertainty about the level of the neutral rate and its forward path, argues for a shallow path of rate hikes.  We expect only one in 2016, most likely in December, followed by three in 2017.
  • We view the “terminal” neutral funds rate to be 2¾%, but the top of the target range won’t hit 2¼% until 2018Q4.
  • We expect the 10-yr yield to end 2016 near 1¾%, 2017 near 2½%, and 2018 near 3.14%.  

This is an excerpt from our most recent Economic Outlook report. To access the full PDF, click here.