Summer is normally a pleasant time, but most Americans are likely to be happy to have August 2017 in the rear view mirror. Civil unrest, tensions abroad, devastation and destruction – yet, the stock market continues to improve. As financial market participants return from the three-day weekend, attention is expected to turn to Washington. Fears of a possible government shutdown or debt default may cause concern, but lawmakers should be able to avoid a self-inflicted wound.
Real GDP growth was revised higher than expected in the 2nd estimate for 2Q17, but the story was essentially the same. Consumer spending rebounded from a “soft” first quarter. Business fixed investment remained strong, with the rebound in energy exploration contributing significantly. The mild winter appeared to shift homebuilding activity ahead to 1Q17. Inventory growth was minimal, a contrast to expectations of a significant rebound. Taking the first two quarters together, real GDP rose at a 2.1% annual rate in the first half of the year, roughly in line with the pace of the last few years. Private Domestic Final Purchases (consumer spending, business fixed investment, residential investment), a better measure of underlying domestic demand, rose at a 3.4% annual rate in 2Q17 (+2.9% y/y), vs. +3.1% in 1Q17.
Hurricane Harvey will have a negative impact on 3Q17 GDP growth, but it will take some time to gauge by how much (note that the Bureau of Economic Analysis does a good job of estimating the impact of hurricanes and other natural disasters, when it can – but the advance estimate of 3Q17 GDP growth isn’t due until October 27). Rebuilding may add somewhat to GDP growth in the quarters ahead, but many residents did not have flood insurance and government infrastructure spending is likely to be limited by budget constraints. Gasoline prices will be higher in the near term, which will dampen consumer spending growth. Claims for unemployment benefits should spike over the next few weeks, but should retreat just as quickly. Nonfarm payroll figures are based on the working period that includes the 12th of the month. Hence, we may see only a moderate impact on job growth (if so, bouncing back in the next month’s report). Retail sales figures will take a hit.
Nonfarm payrolls rose less than expected in August (+156,000), with a downward revision (-41,000) to June and July. Contrary to headlines in the financial press, job growth did not “slow” in August. Remember, the monthly change in payrolls is reported accurate to ±120,000. That means that we can be 90% certain that the true monthly change was between +36,000 and +276,000. Statistical uncertainty and seasonal adjustment add noise to the payroll data, but we can reduce (not eliminate) that by looking at averages. Private-sector job growth in 2017, looks a lot like in 2016. We have seen increased business optimism this year, which ought to coincide with better job growth. However, we’re also seeing tighter job market conditions.
Average hourly earnings rose modestly in the initial estimate (+0.1%) for August. The year-over-year trend remains stuck at 2.5% – moderate, but less than one would expect given the low unemployment rate. There are a few theories as to why this is the case and we can expect to hear that from senior Fed officials (Governor Lael Brainard on September 5, Chair Janet Yellen in her September 20 post-FOMC press conference).
The House and Senate will be back in session this week. Tax reform is the main agenda, but officials will need to work on completing a budget for FY18 (which starts October 1) and raising the debt ceiling (Treasury Secretary Mnuchin has signaled a drop dead date of September 29). We’ve had government shutdowns before, and we were driven to the brink of a default in 2011. None of that is necessary. The debt ceiling is a stupid law. Congress already controls the annual budget. In the past, both parties have used the debt ceiling to extract concessions from the other party, usually with some modest success. In recent years, the debt ceiling has grown more contentious. What makes the current situation unique is that it is largely Republicans (White House) vs. Republicans (Congress). Hence, threats to shut down the government seem a little misplaced. On Friday, the White House signaled that it would drop the demand that the FY18 budget include funding for the wall (which is opposed by Congress). Note that even if agreements on the budget and debt ceiling can’t be reached in time, lawmakers can easily kick the can down the road.
As noted previously, tax reform, while badly needed, is virtually impossible. The U.S. has one of the highest corporate tax rates in the world, but the effective rate (what firms actually pay) is one of the lowest. Tax breaks and subsidies are enormous, and no one receiving them wants to give them up. A recent paper by the Institute on Taxation and Economic policy argues that many large corporations pay little to no taxes at all. Reducing the corporate tax rate and eliminating deductions would mean that these firms would pay more in taxes. Moreover, there’s no evidence that lower effective tax rates have led these firms to create jobs. For the most part, tax policy is more political in nature (who pays), not economic.
This isn’t to say that reforms aren’t needed. They are. The current system is inefficient and creates distortions even within industries (companies in the same sector can pay significantly different effective tax rates). Real tax reform would make it fairer and allow the more innovative firms to succeed. It would revive the entrepreneurial spirit, supporting economic growth as the economy faces demographic constraints.
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All expressions of opinion reflect the judgment of the Research Department of Raymond James & Associates (RJA) at this date and are subject to change. Information has been obtained from sources considered reliable, but we do not guarantee that the foregoing report is accurate or complete. Other departments of RJA may have information which is not available to the Research Department about companies mentioned in this report. RJA or its affiliates may execute transactions in the securities mentioned in this report which may not be consistent with the report's conclusions. RJA may perform investment banking or other services for, or solicit investment banking business from, any company mentioned in this report. For institutional clients of the European Economic Area (EEA): This document (and any attachments or exhibits hereto) is intended only for EEA Institutional Clients or others to whom it may lawfully be submitted. There is no assurance that any of the trends mentioned will continue in the future. Past performance is not indicative of future results.
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