At 2.2% quarter-on-quarter (QoQ) on an annualised basis, expectations for US economic growth in the fourth quarter of 2016 were modest. However, the preliminary estimate, published on 27/01/17, came in even lower. According to this data, US growth slowed from 3.5% in the third quarter to 1.9% in the final quarter of 2016.
The biggest drag on US economic growth: net trade
Exports slumped by 4.3% QoQ annualised, while imports leapt by 8.3%. This is a quirk, explained by events in the soybean market in Q3 2016 – soybean exports surged as drought in Latin America created a one-off spike in demand for US soybeans. The decline in exports in Q4 was a partial unwinding of this exceptional rise in demand.
Overall, net trade detracted 1.7 percentage points from growth. Inventory building added to growth for the second straight quarter and was stronger than in the previous six quarters. In our view, the inventory correction, which has had a negative impact on business sales and industrial production, has ended. If we are right about this, then this is a positive for US economic growth in 2017.
Excluding the volatility in the data of net trade and inventories, domestic final demand – made up of consumption (broken down into consumer spending and government spending) plus business and residential investment – accelerated slightly to 2.5% QoQ on an annualised basis. Consumption growth slowed somewhat. We have recently outlined our view that we do not anticipate that the exuberance in consumer confidence will lead to a surge in actual spending.
Exhibit 1: Changes in quarterly US real gross domestic product (GDP) and contributions (in percentage point) of the principal components to GDP from 2008 through 30/01/17
Employment growth has moderated somewhat and while nominal wage growth has accelerated, real wage growth has been impacted negatively by higher inflation (see Exhibit 2).
Exhibit 2: US employment and hourly wages (% YoY). Employment growth has moderated, but real wage growth has been negatively impacted by higher inflation (the graph shows changes in nominal wages, real wages and employment in the US between 2000 and 30/01/17)
Business and residential investment both added more to GDP than in previous quarters
Business investment tends to be quite volatile, but the trend seems to be improving. In Q4 2016 investment in equipment was positive for the first time in five quarters. The weakness in business investment in 2016, when capital expenditures fell for the first time since 2009 – was not just related to the troubled energy sector, but more broad-based. Falling profits and the strong inventory correction cycle also played a role. As I have already pointed out, the drag from these factors seems to have run its course.
Durable goods orders fell in December due to another large fall in aircraft orders, but orders for capital goods were up. Orders and shipments of capital goods actually bottomed last summer (see Exhibit 3). Sentiment among producers has also improved. In January the PMIs for the US manufacturing and services sectors rose further. The composite index jumped to its highest since October 2015.
Exhibit 3: Order and shipments of US capital goods (excluding defense and aircraft, USD billion) bottomed in the summer of 2016 and rose in the fourth quarter of 2016
So, overall we are constructive on the outlook. We expect US economic growth to continue at or possibly a bit above its long-term trend. We see three reasons not to get overly exuberant:
(i) rising inflation will have a negative impact on consumer spending power
(ii) the strong US dollar will weigh on exports
(iii) the increase in US bond yields constitutes a tightening of financial conditions for the US economy.