United States / Spotlight Reports
Q4 Macro Update: Persistent Growth Accompanies Policy Change

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by Robert Miles, Brian Sayler, Mario Ismailanji and Viraj D'Costa
Mar 06 2018

The fourth quarter of 2017 was characterized by high levels of consumer spending, strong growth in both?residential and nonresidential?investment and increased government spending at both the state and local levels. Additionally, rising rates of private fixed investment and surging growth in the US technology sector caused US?financial markets?to experience significant growth in Q4 2017, with major stock market indices, such as the S&P 500, repeatedly hitting record highs during the three-month period. Conversely, economic growth has been somewhat constrained in recent months by a downturn in private inventory investment, as well as consistent growth in the value of US imports. Overall, according to revised data from the Bureau of Economic Analysis (BEA), inflation-adjusted Gross Domestic Product (GDP) increased at a seasonally adjusted annualized rate of 2.5% during the fourth quarter of 2017, falling short of annualized growth of 3.2% during the previous quarter.

Q4 was also notable due to the passage of the Tax Cuts and Jobs Act (TCJA) of 2017, which represents the largest overhaul to federal tax policy in several decades. The bill reduces the corporate tax rate from 35.0% to 21.0% and repeals the individual healthcare mandate stipulated by the Patient Protection and Affordable Care Act. Additionally, the TCJA reduces income tax rates for individuals in most income brackets, essentially doubles the standard tax deduction for both single and joint filers and abolishes the personal exemption, as well as state and local tax exemptions. Overall, the Tax Policy Center estimates that 80.0% of US households will receive a tax cut in 2018 but also projects an expansion of the national deficit if growth does not offset reduced revenues.

Consumer Spending and Labor

In the fourth quarter of 2017, the US economy added 647,000 nonfarm jobs. Moreover, according to the Bureau of Labor Statistics (BLS), an additional 200,000 nonfarm jobs were added in the first month of 2018. Monthly job gains of 150,000 or more typically indicate that the labor market is growing. Service-based industries, in particular, posted large increases. In January specifically,?food services?and drinking places added 31,000 jobs,?healthcare?added 26,000 jobs and?professional and business services?added 23,000 jobs (despite 10,000 fewer jobs in accounting and bookkeeping services). However, employment in the?information?and?utilities?sectors declined by 6,000 and 1,400 jobs, respectively. Overall, the unemployment rate remained at its nearly two-decade low of 4.1% for the fourth straight month. Though the unemployment rate remains below the natural rate, the number of part-time workers remains above prerecessionary levels. According to the BLS, there were 27.4 million part-time workers in January.

q4 macro graph

The labor force participation rate (LFPR) has steadily declined over the past decade. In the fourth quarter of 2007, the LFPR averaged 65.9%. Comparatively, in the fourth quarter of 2017, the LFPR averaged 62.7%. This drop has largely been the result of underlying demographic shifts in the US economy, rather than economic trends. For instance, the retiring baby-boomer generation, as well as individuals staying in school longer, inversely affect labor force participation. According to BLS data, average hourly earnings grew faster than anticipated in January, growing 2.9% from the prior year to $26.74, the fastest they have grown since 2009. In line with this increase in hourly earnings, consumer spending has also expanded. The rises in employment and the acceleration of wage growth point to an economy that is hitting its stride. However, these factors of accelerating wages and low unemployment bring along concerns of inflationary pressures. Increases in wages tend to result in higher prices for goods and services because businesses, at least partially, pass wage costs onto consumers. As inflation has hovered near the Federal Reserve’s stated target rate of 2.0%, an acceleration in wage growth raises the likelihood of interest rate hikes by the Fed in the near future.

Personal consumption expenditures (PCE) grew at a healthy pace during Q4 2017, increasing 0.4% in December, 0.7% in November and 0.3% in October. PCE increased $34.4 billion in December, with services ($23.2 billion) and durable goods ($11.1 billion) making up for a decline in nondurable good spending driven by lower gasoline and energy costs. Furthermore, the 12-month core PCE Price Index, which excludes the high price volatility of food and energy, rose 1.5% in both December and January. As a result, inflation is still below the Fed’s target rate of 2.0%. Nonetheless, due to the tight labor market and accelerating wages, inflation is expected to rise closer to the target rate in the near-to-medium future.

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Fixed Investment and?Construction?Trends

The rate of expansion in private fixed investment accelerated in the fourth quarter of 2017. According to the Bureau of Economic Analysis (BEA), gross private domestic fixed investment (seasonally adjusted and chained 2009 dollars) increased 8.1% in the fourth quarter. This represents a significant uptick from 2.4% in Q3 and matches the robust growth exhibited in Q1. The primary contribution to fixed investment came from nonresidential structures, but a warm winter aided the rebound in residential investment during the quarter.

According to the BEA, residential and nonresidential investment increased 13.0% and 6.6%, respectively, during the fourth quarter. Nonresidential investment, in particular, can be analyzed through the lens of construction spending data. When December 2017 is compared to a year earlier, a clear distinction in spending on nonresidential structures emerges. The value of construction put in place, from the US Census Bureau, reports that transportation spending increased 12.9% and?manufacturing?fell 11.7%. This suggests a clear directional shift in spending from manufacturing establishments to the means of distribution once production is complete.

New housing permits in December increased a significant 2.8% from 2016. Moreover, when measured at a seasonally adjusted annualized rate, these permits increased 6.3% during the quarter. However, when a six-month moving average is applied, the growth rate on housing permits has been significantly lower throughout all of 2017. This suggests that the actual rate of expansion is falling and that the observed quarterly growth is likely attributable to unseasonably warm weather. Though fundamental demand factors for residential demand have remained strong, the growth cycle appears to have peaked. The successive quarters of poor performance suggest that much of the demand for new residential construction has already been satiated.

Financial Markets

Merger and acquisition (M&A) activity and initial public offerings (IPOs) continued to grow over the fourth quarter of 2017. As of December 31, IPO filings grew 57.8% from 2016. Such a rebound was expected, given that M&A and IPO activity tend to decline during presidential election years, as companies put off major investments until the new administration’s likely policy stances are known. Equity markets mirrored the improvements to business sentiment, with the S&P 500 once again breaking all-time highs as companies from the technology sector such as Apple, Amazon and Facebook drove growth. Even with positive activity within equity markets, demand for fixed-income investment vehicles grew through the third quarter and has continued its trajectory through today.

Some of this is explained by the relative strength of the US economy when compared with other actors on the global stage. A brighter economic outlook for the United States has increased demand for US securities, driving yields downward. While US financial markets experienced substantial growth during the fourth quarter, recent uncertainty surrounding mounting inflation and the potential for future interest hikes resulted in a market correction in February. The largest single-day decline in the history of the Dow Jones Industrial Average (DJIA) occurred on February 5, 2018.

Continued interest rate hikes by the Federal Reserve are expected to increase investor uncertainty and keep yields from growing significantly in 2018. Currency markets followed a different trajectory during fourth quarter of 2017, as the dollar’s gains resulting from the presidential election were entirely erased. Indeed, the trade-weighted index, which measures the strength of the US dollar against the currencies of several major US trading partners, has fallen from its peak of 103.2 index points at the end of 2016 to 96.6 index points at the end of 2017. This decline has caused US-manufactured goods to depreciate relative to their foreign competitors, making US goods more attractive to foreign consumers.

IBISWorld Report on Q4 Macroeconomic Update

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