John Lynch Chief Investment Strategist, LPL Financial
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After a seasonally weak first quarter, expectations have been ramping up for the U.S. economy, which is now in the midst of its longest expansion since World War II. The first look at real gross domestic product (GDP) for the second quarter will be released Friday, July 27, and economists are expecting it to be the strongest reading in years. The median Bloomberg-surveyed economist forecast is for GDP growth is 4.0%, which, if realized, would be the largest quarterly increase since 5.2% growth in the third quarter of 2014.
FISCAL STIMULUS: A TAILWIND FOR GROWTH
The domestic economy has begun to reap the benefits of supportive fiscal policy, which includes lower tax rates for individuals and corporations, deregulation, and increased government spending. A key driver of the pickup in growth, if realized, would be a rebound in consumer spending, which accounts for about 70% of the economy. First quarter consumer spending was weak after a strong fourth quarter last year, but recent numbers for the second quarter have been upbeat. Retail sales rose for a fifth straight month in June, coming in near expectations but with a large upward revision to May data, while already strong consumer confidence has steadily improved.
We can see stronger consumer spending data reflected in the Federal Reserve (Fed) Bank of Atlanta’s GDPNow forecast of second quarter growth [Figure 1]. While we don’t put too much faith in a single forecast and the model’s projection of 4.5% growth for the quarter is above consensus, the model does provide a helpful picture of how different economic sectors may contribute to second quarter growth based on data received to date. The forecast shows considerable improvement in the contribution from consumer spending, which would be needed even to meet the 4% consensus target.
We also anticipate continued strength in business spending to contribute to a healthy picture of the economy in the second quarter, as incentives for increased capital investment in the new tax law encourage companies to build out their infrastructure. Business spending has been accelerating since an oil-related slowdown in 2015 and early 2016, and posted some of its strongest growth in the cycle in the first quarter [Figure 2]. While we expect the momentum to continue, the contribution to GDP growth in the second quarter may decline after strong first quarter growth helped offset weakness in consumer spending.
EXPORTS RISE AMID TARIFF TENSIONS
Trade tensions have dominated headlines recently. Tariffs on $49 billion in goods have already been implemented and tariffs on $200 billion or more of additional Chinese goods have been discussed, along with tariffs on automobiles.
Anxiety around a global trade war has fueled a jump in U.S. exports ahead of tariffs, which, in turn, has closed the trade deficit to its smallest point since 2016. Net exports averaged $144 billion in March, April, and May, the highest three-month rolling average of the current expansion. The increase in exports is primarily from increased demand as purchasers try to beat retaliatory tariffs, evidenced by soybeans and civilian aircrafts comprising almost all of the jump in exported goods in May. The Atlanta Fed’s NowCast model estimates that net exports may account for 0.7% of their 4.5% GDP growth forecast for the second quarter, which would be its strongest contribution since 2013 if realized.