The economy rolled on in the third quarter of 2017, growing by 3%, despite the hurricanes that battered the United States during the quarter. While the storms reduced spending on both home and business construction, a surge of new-car buying took place in September as flood victims in Texas replaced damaged vehicles.
The economic momentum should continue into the fourth quarter. Consumer spending is likely to remain strong, given the jump in consumer sentiment surveys in October. Business investment in equipment is picking up. And extra spending to repair damage from the hurricanes will continue to boost the economy. Tens of thousands of houses still need to be repaired, and tens of thousands of vehicles need to be replaced. Houston alone will need to ship or truck in tons of freight to replace what was lost.
Expect a pickup in growth to 2.6% in 2018, after 2017’s 2.2% full-year pace. Not only will recent economic momentum continue, but there is likely to be some extra boost from any tax plan passed by Congress. Consumer spending will be underpinned by rising household wealth and income, continued job gains (albeit at a reduced rate) and increasing use of credit. However, expect motor vehicle sales to slow significantly once flood-related replacement buying tapers off.
The improved climate for business spending will continue in 2018, with a high level of equipment purchases and increasing business construction. Business spending on inventories will rise as well. Home building should rev up, given the shortage of homes for sale relative to demand from would-be buyers.
Government spending is likely to stay flat, except for defense, and thus contribute little to GDP growth. Federal hiring is no longer completely frozen but will remain extremely slow, partly because of the dearth of middle-management political appointees who approve new federal government hires. State and local governments’ spending plans are cautious, given the uncertainty of federal funding for Medicaid and other programs supported by Uncle Sam.
The Federal Reserve is expected to hike interest several times next year. Despite low inflation of 1.3% in its core consumer measure, the Fed will decide that GDP growth is strong enough to justify its plan to boost the short-term federal funds rate to 3% by 2020 from 1.25% now, unless the economy slows sharply. The Fed’s rate hikes will push up the bank prime lending rate to 6.25% by 2020, weighing on auto sales and other consumer spending that is financed by short-term interest rates. However, the long-term rates that affect mortgages are likely to stay low if inflation remains tepid, which we expect to be the case for a while.