Implications:  Orders for durable goods ended 2017 on a high note, rising 2.9% in December on the back of surging aircraft orders.  But even excluding the volatile transportation sector, orders increased 0.6% in December, and rose 8.2% in 2017, the largest annual increase going back 2010.  Add in that orders have been accelerating, with total durable goods orders up at an 18% annual rate over the past three months and ex-transportation orders up at a 9.9% rate over the same period, and 2018 looks to be in line for a strong start. The details of non-transportation orders in December show mixed results. Healthy increases for primary metals, fabricated metal products, and machinery more than offset modest declines in orders for electrical equipment, appliance & components, and computer & electronic products. With tax reform signed into law in late December – including a shift to full expensing for business investment instead of depreciation over several years – we expect orders (particularly machinery orders) to continue to pick up as companies increase investment. The best news in today's report was for shipments of non-defense capital goods ex-aircraft, or "core" shipments – the measure most important for calculating the business equipment portion of GDP growth.  These shipments increased 0.6% in December and were up at a 12.5% annual rate in Q4 vs the Q3 average, the second consecutive quarter of double-digit growth.  This reflects the willingness of businesses to invest more aggressively for efficiency purposes as the labor market gets tighter, and a positive outlook for companies headed into 2018.  As a whole, durable goods orders continue to show signs of an economy that is picking up pace, with better policies out of Washington adding wind to its back.

Click here for PDF version

Implications:  The headline growth rate of 2.6% for fourth quarter real GDP and 2.5% for 2017 make the economy look like it's still a Plow Horse, but the details of the report show it's not.  The parts of GDP that are the most volatile from quarter to quarter – international trade and inventories – were major drags on growth in Q4.  We like to follow "core" GDP, which we define as consumer spending, business investment in equipment, structures, and intellectual property, as well as home building.  Adjusted for inflation, core GDP grew at a 4.6% annual rate in Q4, the fastest pace since 2014, and rose 3.3% in 2017.  Consumer spending was very strong in Q4, in part due to the surge in auto sales late in the year to replace vehicles destroyed in Hurricanes Harvey and Irma.  Meanwhile, home building grew at an 11.7% annual rate, the fastest in over a year.  Business investment in equipment grew at an 11.4% rate, the fastest since 2014.  We expect real GDP to grow at a 3%+ rate in 2018, which would be the first year that's happened since 2005.  In particular, the tax cuts enacted in late December and the deregulation coming from Washington, DC are going to help spur faster growth.  Meanwhile, today's report makes it even clearer the Federal Reserve is behind the curve.  Nominal GDP – real GDP growth plus inflation – grew at a 5.0% annual rate in Q4, was up 4.4% in 2017, and up at a 3.9% annual rate in the past two years.  All of these are much higher than the Fed's current target for short-term rates of 1.375%.  The Fed has been saying it will raise short-term rates three times in 2018.  The investor consensus has recently come around to that view as well, but thinks the odds of two rate hikes is higher than the odds of four.  We think the opposite, that if the Fed doesn't raise rates three times in 2018, it will be four hikes, not two.

Click here for PDF version

Implications:  New home sales came in weaker than expected in December, posting their biggest monthly decline of the year, as the boost in sales following the hurricanes finally ran its course.  Sales of new homes fell 9.3% in December, but are still up 14.1% from a year ago.  Despite the disappointing headline number, the details of the report show the upward trend in sales remains, with 2017 posting the highest annual total in a decade.  The biggest drag on today's number came from the South, which alone represented 56% of the decline in the pace of sales.  This represents a return to trend after Hurricanes Harvey and Irma caused many people in that region to buy new homes to replace those destroyed in the aftermath, temporarily driving up activity.  Going forward it's important to remember that new home sales are volatile from month to month, but prospects remain good for further growth over the next few years. Sales of new homes were typically about 15% of all home sales prior to the end of the housing bubble in the previous decade.  They fell to about 6.5% of sales at the bottom of the housing bust and now have recovered to about 10%.  And if there's plenty of room for growth in new home sales, that means plenty of room for home building to grow as well.  Yes, inventories posted their largest monthly gain since 2006 in December and now sit at a post-crisis high. But this monthly gain was almost entirely due to homes where construction has yet to even start, and completed units make up only 22% of overall inventories, which means builders still have plenty of room to expand.  With jobs continuing to grow at a healthy pace, wages accelerating, and a tax cut taking effect, we maintain our optimism about home building in the years ahead.  Although the new tax law trims back the mortgage interest deduction for some high-end homes, the value of the mortgage interest deduction was affected more broadly by the marginal tax rate reductions in the 1980s, during which housing did well.  Yes, the new tax law also trims back state and local tax deductions, including the property tax, but we think that's going to affect where people live, not overall home building nationwide.  The US economy is looking up and housing is one of the sectors leading the way.  In other news this morning, initial jobless claims rose 17,000 last week to 233,000.  Meanwhile, continuing claims fell 28,000 to 1.937 million.  Expect payroll growth of about 175,000 in January, another solid month.

Click here for PDF version 

Implications:  After three straight months of gains, existing home sales ended 2017 on a soft note.  Sales of previously-owned homes fell 3.6% in December to a 5.57 million annual rate, but are still up 1.1% from a year ago.  Despite the weak headline number, sales posted their best year since 2006, showing the upward trend is still intact.  And now that the effects of the hurricanes have mostly subsided, there may be some pent-up demand to provide a tailwind to sales in early 2018.  That said, the major headwind for existing homes has been inventories, now lower on a year-over-year basis for 31 consecutive months, down 10.3% from a year ago, and at the lowest level since at least 1999.  The number of existing homes for sale declined 11.4% in December alone to 1.48 million. This drop was large enough to more than offset the slower pace of sales, pushing the months' supply of existing homes – how long it would take to sell the current inventory at the most recent sales pace – to 3.2 months in December, also the lowest level on record.  According to the NAR, anything less than 5.0 months (a level we haven't breached since 2015) is considered tight supply.  Despite the lack of options, demand for existing homes has remained remarkably strong, with 44% of homes sold in December remaining on the market for less than a month.  Higher demand and a shift in the "mix" of homes sold toward more expensive properties has also driven up median prices, which are up 5.8% from a year ago.  The strongest growth in sales over the past year is heavily skewed towards the most expensive homes, signaling that supply constraints may be disproportionately hitting the lower end of the market.  Tough regulations on land use raise the fixed costs of housing, tilting development toward higher-end homes.  Although some analysts may be concerned about the impact of tax reform on home sales, the reality is that few homeowners exceed the new thresholds for deductibility.  Finally, though mortgage rates may be heading higher, it's important to recognize that rates are still low by historical standards, incomes are growing, and the appetite for homeownership is starting to move higher again.  That's why we expect home sales, like the stock markets, to move higher in 2018.  In other housing news this morning, the FHFA index, which measures prices for homes financed by conforming mortgages, rose 0.4% in November and is up 6.6% in the past year, little different from the 6.5% gain in the year ending November 2016.  Look for further price gains in the year ahead, although at a slightly slower rate and, given recent tax changes, with growth tilted more toward lower tax states.  On the manufacturing front, the Richmond Fed index, a measure of mid-Atlantic factory sentiment, came in at a still robust 14 in January versus 20 in December.

Click here for PDF version

We've called the slow, plodding economic recovery from mid-2009 through early 2017 a Plow Horse.  It wasn't a thoroughbred, but it wasn't going to keel over and die either.  Growth trudged along at a sluggish – but steady - 2.1% average annual rate.

Thanks to improved policy out of Washington, the Plow Horse has picked up its gait.  Under new management, real GDP grew at a 3.1% annualized rate in the second quarter of 2017 and 3.2% in the third quarter.  There were two straight quarters of 3%+ growth in 2013 and 2014, but then growth petered out.  Now, it looks like Q4 clocked in at a 3.3% annual rate, which would make it the first time we've had three straight quarters of 3%+ growth since 2004-5.

Some say a government shutdown would make it tough to get another 3% quarter to start 2018, but we disagree. Yes, some "nonessential" government workers might pull back on their spending temporarily, but there's no historical link between government shutdowns and economic growth. 

The economy grew at a 2.8% annual rate in late 1995 and early 1996 during the two quarters that include the prolonged standoff under President Clinton.  That's essentially no different than the 2.7% pace the economy grew in the year before the shutdowns.  The last time we had a prolonged standoff was in late 2013, under President Obama.  The economy grew at a 4% rate that quarter, one of the fastest of his presidency.      

Right now, taxes are falling, regulations are being reduced, and monetary policy remains loose.  With these tailwinds, the acceleration of growth in 2017 should continue into 2018. 

Here's how we get to 3.3% for Q4.

Consumption:  Automakers reported car and light truck sales rose at a 16.4% annual rate in Q4, in part due to a surge after Hurricanes Harvey and Irma.  "Real" (inflation-adjusted) retail sales outside the auto sector grew at a 6.6% rate, and growth in services was moderate.  Our models suggest  real personal consumption of goods and services, combined, grew at a 3.9% annual rate in Q4, contributing 2.7 points to the real GDP growth rate (3.9 times the consumption share of GDP, which is 69%, equals 2.7).

Business Investment:  Looks like another quarter of solid growth, with investment in equipment growing at about a 16% annual rate, and investment in intellectual property growing at a trend rate of 5%, but with commercial construction unchanged.  Combined, it looks like business investment grew at an 8.8% rate, which should add 1.1 points to real GDP growth.  (8.8 times the 13% business investment share of GDP equals 1.1).

Home Building:  Given the major storms in Q3, we expected a larger pickup in home building than was realized in the fourth quarter.  But it still grew at about a 2.6% annual rate in Q4, which would add 0.1 points to the real GDP growth rate.  (2.6 times the home building share of GDP, which is 4%, equals 0.1).

Government:  Both military spending and public construction projects were way up in the quarter, suggesting real government purchases up at a 2.7% annual rate in Q4, which would add 0.5 points to the real GDP growth rate.  (2.7 times the government purchase share of GDP, which is 17%, equals 0.5).

Trade:  At this point, we only have trade data through November.  Based on what we've seen so far, it looks like net exports should subtract 1.2 points from the real GDP growth rate in Q4.  

Inventories:  We have even less information on inventories than we do on trade, but what we have so far suggests companies stocked shelves and showrooms at a slightly faster rate in Q4, which should add 0.1 points to the real GDP growth rate.

Some more reports on inventories and trade due this week could change our forecast slightly, assuming a shutdown doesn't interfere with the data schedule.  But, for now, we get an estimate of 3.3%.  The US economy is confirming the optimism behind the stock market rally.

Brian S. Wesbury - Chief Economist
Robert Stein, CFA – Deputy Chief Economist 

Click here for PDF version

Source: St. Louis Federal Reserve FRED Database