Real GDP increased at a slower annual rate of 2.0% in the first quarter of 2018, according to the third estimate from the Bureau of Economic Analysis, down from a robust 2.9% annual rate in the fourth quarter of last year. The 2.0% growth rate represents a two-tenths of a percentage point deceleration from the 2.2% reported in the second estimate and is three-tenths of a percentage point below the 2.3% printed in the advance estimate.
The downward revision of 0.2 percentage points from the second estimate reflected somewhat smaller contributions from private inventory investment, consumer spending, and exports that were partially offset by an upward revision from business investment spending.
The 2.0% growth rate – while admittedly weaker than the second half of 2017 – is almost on par with the annual average growth rate of 2.2% since the recession ended in mid-2009. It is also a vast improvement over the U.S. economy's performance in the first quarter of 2016 and 2017, when GDP grew 0.6% and 1.2% respectively.
So how is the second quarter shaping up now that we have the final Q1 GDP data in hand, and what does it mean for the U.S. outlook going forward? In our view, the near-term U.S. outlook will be a battle between consumer and business optimism generated by tax cuts and a strong labor market against decelerating global growth, increased financial market volatility, tighter monetary policy, and a widening trade war. In short, the U.S. outlook remains solid for this year, though growth will likely peak in the current quarter both on a quarterly annual basis and on a year-over-year basis.
Consumers to the Rescue in the Second Quarter
Recent stronger-than-expected economic data – from commercial construction to exports – has caused us to revise up our forecast for second quarter GDP growth to a sizzling 4.4%. This would be the highest growth rate since the 5.2% recorded in the third quarter of 2014 and is 220 basis points above average annual growth since the end of the recession.
But the rebound in Q2 GDP growth is primarily due to personal consumption expenditures, which is projected to accelerate from just 0.9% in the first quarter to 2.8% in the second quarter. Supporting consumer spending gains are a strong labor market (the unemployment rate hit an 18-year low of 3.8% in May), firm real disposable income growth (partly due to tax cuts), record-high household net worth, and elevated levels of consumer confidence. Labor market strength is expected to carry over into June. We forecast non-farm payrolls will increase by another 195K jobs with average hourly earnings increasing at a robust 3.6% annualized rate when the June employment data is released next Friday.
Undoubtedly, equity values remain stretched despite recent declines brought on by increasing trade tensions. However, they are firmly above year-ago levels; and inflation-adjusted real estate net worth continues to rise, although it was still about 10% below its 2005 peak at the end of 2017. Furthermore, our forecast has home prices increasing 6.6% this year and 4.8% in 2019, supporting additional gains in real estate net worth.
The Outlook
Our forecast calls for real GDP growth to moderate to 2.7% for the balance of 2018 after reaching 4.4% in the second quarter. On an annual basis, growth is expected to come in at 3.0% this year, up sharply from 2.3% last year. To put the 3.0% growth rate into perspective, the economy hasn't grown at that pace since expanding by 3.3% in 2005 – approximately two years before the Great Recession began. Furthermore, the only post-recession year that growth came close to 3.0% was in 2015, when the economy expanded by 2.9%.
Growth is expected to decelerate to a still-respectable 2.5% year-on-year in 2019 – a rate most economists consider to be well above U.S. potential growth – as job creation slows with the economy already at full employment, and the benefits of the tax cuts begin to fade.
What could go wrong with this Goldilocks forecast, you ask? A full-blown multilateral trade war that goes beyond reciprocal tariffs, drags down business and consumer confidence, and touches off a nasty bout of financial instability is a leading contender today. But keep one eye on emerging market contagion, China's slowdown, rising populism in Europe and Mexico, and more aggressive monetary tightening as events that could upset the apple cart and shake the U.S. economic outlook.