What Matters Most in Q3 GDP

Jon C. Ogg

Friday will be showtime for the first reading on third-quarter gross domestic product (GDP). This is the ultimate measurement of the U.S. economy, which is now running in the $20 trillion per annum level. While GDP is still expected to be above trend, the reality is that the higher growth estimates have come down from expectations in prior weeks and months.

Earnings reporting season has boded poorly for corporations releasing third-quarter earnings and guidance. Most of the earnings weakness is tied to issues that occurred late in the third quarter and that have surfaced in the fourth quarter.

What investors need to understand is that whatever the growth number happens to be, it is really how investors feel about the fourth quarter that will matter the most. The 4.2% GDP growth seen in the second quarter is now called on as coming in at 3.4% in a Dow Jones consensus estimate. The most recent Reuters poll showed a consensus of 3.3% for third-quarter GDP.

Upon the release of the durable goods report for September, there was a cooling off of business spending on equipment, and the deficit in goods trade rose. The U.S. Department of Commerce’s report showed that the reading on non-defense capital goods, excluding aircraft, was down by 0.1% in September. While the number is barely in the red, it signaled weaker demand for appliances, components, fabricated metals and electrical equipment. Unfortunately, that followed a 0.2% decrease in August’s core capital goods spending.

Meanwhile, the Commerce Department also reported that the trade deficit in goods rose by 0.8% to $76.0 billion in September. Exports of goods rose by $2.5 billion to $141.0 billion, but the gains seen in industrial supplies, motor vehicles and consumer and capital goods were pulled down by food exports. The imports of goods rose by $3.1 billion to $217.0 billion.

Helping to offset at least some of the drag from the deficit and from the core durable goods readings, wholesale inventories rose by 0.3% and retail inventories rose by 0.1% in September.

The Federal Reserve Bank of Atlanta’s GDPNow model has been updated to reflect the most recent September economic reports, and it now estimates that real GDP will show seasonally adjusted annual growth rate of 3.6% for the third quarter of 2018. This new October 25 forecast is down from the prior 3.9% seasonally adjusted annual growth rate that had been forecast on October 17. The most recent drop is well below the prior forecasts, and that is due to slower growth and other areas of contraction that came in over recent weeks. The GDPNow report says:

The nowcast of third-quarter real residential investment growth fell from -1.6 percent to -4.1 percent after housing market reports from the National Association of Realtors and the U.S. Census Bureau. An increase in the nowcast of third-quarter real nonresidential equipment investment growth from 2.7 percent to 3.8 percent was more than offset by declines in the nowcasts of the contributions of net exports and inventory investment to third-quarter real GDP growth from -1.11 percentage points and 2.20 percentage points, respectively, to -1.24 percentage points and 2.08 percentage points, respectively, after this morning’s advance reports on durable manufacturing, international trade, and inventories from the Census Bureau.

One last issue that may have an impact is the Federal Reserve’s Beige Book release, which came out on Wednesday. This is information should already be known, but it highlights a heightened uncertainty over tariffs, input costs and labor shortages. That data were collected from outside business contacts on or before October 15, and the trend is modest to moderate growth at the start of the fourth quarter.

The official Federal Reserve stance is that interest rate hikes are expected to continue back to a neutral level, but there are continued warnings and fears that the Fed will overshoot if it is looking at economic reports rather than including forecasts and uncertainties around major U.S. businesses. That said, investors need to keep in mind that Friday’s GDP report covers the data from July 1 through September 30, and much of that period was looking stronger than the reports that have been seen into the end of September and throughout October.