By John Beuerlein, chief economist, Pohlad Companies
Most recent economic reports during the past month continue to paint the picture of an improving economy.
The Bureau of Economic Analysis (BEA) confirmed on August 29 that 2Q-18 real GDP grew at the fastest rate since 3Q-14. The original estimate of a 4.1% annualized pace of real growth in 2Q was revised upward to 4.2%. 1Q-18 real GDP was 2.2%.
More recently, on September 7, the Labor Department reported that August payrolls grew by 201,000. The prior two months were revised down by a combined 50,000, indicating that hiring was not quite as robust as originally thought – most likely impacted by a shrinking supply of labor.
The thesis of shrinking labor supply was supported by the rise in wages included in the report. Average hourly earnings grew 2.9% year over year, a post-recession high and the best since April 2009. Additionally, the number of employed persons working part time for economic reasons fell by nearly 200,000, and the pool of available labor declined to the lowest level since 2007 after contracting by a little over 300,000. There are more job openings than there are unemployed people. Labor shortages and skills mismatches remain a top concern of employers. In short, labor is slowly gaining some leverage with employers.
Despite the improvement in nominal earnings, average hourly earnings growth of 2.9% year over year is just keeping pace with inflation. In other words, there has not been any real improvement in earnings when measured against inflation.
As workers are becoming more expensive, business investment is increasing, resulting in improvements in productivity. The corporate tax cuts and capital investment incentives also help promote business investment spending. The improvement in business investment is an important development with significant ramifications. It is noteworthy because there are only two ways to increase GDP: increase the size of the labor force or increase the output of the labor force (productivity).
On the interest rate front, it is a foregone conclusion that the Fed will increase the Fed Funds rate at their September meeting, bringing the rate to 2.25%. The bigger question is whether or not they will raise rates another 0.25% at their December meeting. The markets are currently assigning a 67% chance that the Fed will increase the Fed Funds rate to 2.5% at their December meeting. Ongoing trade tensions coupled with the continued strength of the U.S. dollar are providing uncertainty about a December rate increase.
The yield curve, as measured by the difference in yields between the 10-year Treasury Bond and 2-Year Treasury Note, remains tight at approximately 24 basis points. The 10-year Treasury yield has been in a tight range between 2.82% and 2.98% since mid-May while the yield on the 2-year has moved higher by about 18 basis points over the same period and is now at 2.65%. This phenomenon is garnering a lot of attention because of its historical track record of accurately indicating that a recession is likely to occur in 12-15 months once the curve inverts. While this relationship warrants continued observation, the point is that even if the curve does invert, there has typically been about a year before the economy begins to slow significantly.
In summary, while 3Q-18 GDP is unlikely to be as strong as 2Q-18, the economy is continuing to advance at what is likely to be the strongest calendar year of growth since 2005 with no imminent signs of a serious slowdown.