Adding Up the Economy, It Looks Like 2018 Q1 GDP May Disappoint
In the March edition of the U.S. Economic Outlook, we talked about the strong start for 2018. We stand by that statement, as corroborated by several economic indictors that were strongly positive in early 2018. Among them are both the ISM Manufacturing and Non-manufacturing Indexes. If we take a quarterly average of these two series and add them together, the combined reading of 119.1 for the first quarter of 2018 was the highest combined reading for those two indexes since 2004Q1. Likewise, unemployment insurance claims have been historically low, and the February payroll gain of 326,000 net new jobs was the biggest gain since October 2015.
However, when we look at how 2018Q1 GDP is shaping up, some components are looking weaker than expected. We have revised down our 2018Q1 real GDP growth forecast to just a 1.6 percent annualized rate. This is about two full percentage points below where some forecasts were at the start of the first quarter. We will get the first estimate of 2018Q1 real GDP growth from the Bureau of Economic Analysis on the morning of April 27. Even if there is a weaker-than-expected first estimate of Q1 GDP, we believe that the U.S. economy is still strong and that will show up in better second and third quarter GDP numbers.
In order to understand how many economic indicators can be strong while GDP is not, it is useful to deconstruct GDP. GDP was designed to be a measure of the flow of production from the U.S. economy. There is no single observable flow of production that we can say is representative of GDP. Instead, GDP is the summation of several different flows within the economy, that can all behave differently at different times. Mathematically GDP = C + I + G + X. That is to say, GDP is the sum of consumer spending, investment, government spending and net exports.
Consumer spending is the largest component of GDP, and is divided into consumer spending on durable goods, nondurable goods and services. In our April forecast we show real consumer spending growing at a fairly weak 1.2 percent annualized rate, after a strong 4.0 percent growth rate in 2017Q4. The main culprit behind the surge and slowdown in consumer spending growth from 2017Q4 to 2018Q1 is auto sales, which show up in consumer spending for durable goods. In 2017Q4, we saw strong auto sales as a result of the damage wrought by Hurricanes Harvey and Wilma. In the first quarter of 2018, unit auto sales declined at a 12 percent annualized rate, normalizing to the pre-storm trend.
Investment is divided into business fixed investment (on buildings and machinery), business investment on inventories, and residential investment (on new houses and improvements to existing houses). Residential investment looks like it will be a weak link in 2018Q1. Three sets of housing-related data look like they will be soft in 2018Q1. In January and February, the value of new residential construction was flat. Single-family housing starts for January and February were flat. Also, single-family home sales for January and February were well below the November peak, pointing to a quarter-to-quarter decline.
Finally, net exports are expected to be a drag on real GDP growth in 2018Q1. Net exports equals the value of exports minus the value of imports. Imports have exceeded exports for the U.S. since 1981Q4, meaning that the U.S. has been running a trade deficit since then, which subtracts from GDP. For the first quarter of 2018, we estimate that imports grew faster than exports, due in part to the television coverage of the Winter Olympics. The roughly $1 billion in television royalties paid to broadcast the games in the U.S. reduced 2018Q1 nominal GDP by a billion dollars.
For a PDF version of this report click here: USEconomicOutlook-0418.
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