Economy: Solid Economic Growth, Manageable Inflation

Economic Data
Overall, October’s economic reports reflected solid U.S. economic growth and manageable inflationary pressures. The Conference Board’s Leading Economic Index (LEI), an aggregate of 10 leading indicators, increased 0.5% in September and 7.0% year over year, signaling low odds of recession in the coming year.
Gross domestic product (GDP) grew 3.5% annualized in the third quarter, boosting average growth over the last two quarters to 3.9%, the strongest pace since 2014. The strong undercurrent of consumer demand drove the economy last quarter, aided by accelerating incomes and fiscal stimulus [Figure 1].

Personal incomes grew in September at nearly the fastest annual pace in three years, while consumer confidence reached an 18-year high, signaling that strong consumer activity may continue to boost output.
Although GDP’s headline growth was solid, the underlying details hinted at some soft patches, primarily among U.S. businesses amid uncertainty from trade tensions and higher costs. The biggest drag on last quarter’s GDP was a decline in net exports, and both exports and imports were net drags on headline GDP for the first quarter since the fourth quarter of 2016. Business’s fixed investment contributed 0.1% to GDP, about 0.4% below its three-year average contribution, amid the growing influence of trade fears on companies’ decisions and outlooks. Orders and shipments of core capital goods both slowed in September to levels not seen since 2014.
Cooling in business investment also weighed on one measure of U.S. manufacturing activity [Figure 2].

The Institute for Supply Management’s (ISM) Purchasing Managers’ Index (PMI) fell from a 14- year high in September as new orders cooled and export orders continued to decline. However, Markit’s PMI, which assigns different weights to its survey components, climbed for the first time in five months. Pockets of weakness in manufacturing were balanced by a strong month for the services sector. ISM’s measure of services activity rose to a record in September, while Markit’s services gauge climbed. Overall, the manufacturing and service industries remain healthy, but we will watch economic data for any further impacts from the U.S.-China trade dispute.
Jobs data showed a continually tightening labor market. September’s jobs report showed nonfarm payrolls posting the smallest monthly increase in a year as Hurricane Florence’s landfall likely weighed on jobs growth. Slowing jobs growth, along with the unemployment rate’s drop to a 48-year low, confirmed a tight labor market at this point in the cycle. Average hourly earnings climbed 2.8% year over year in September, significantly below the 4% wage growth preceding each of the last five economic recessions. Wages represent up to 70% of business costs, so current wage growth shows inflation has yet to reach levels that could weigh on output.
Producer prices continued to climb, but data showed higher production expenses haven’t boosted consumer prices significantly. The core Producer Price Index (PPI), which excludes the volatility in pricing of food and energy components, rose 2.7% year over year, its fastest pace of growth since 2012. Even so, the core Consumer Price Index (CPI) increased 2.2% year over year, below its 2.4% cycle-high growth, reached in July. Core Personal Consumption Expenditures (PCE), the preferred gauge of inflation of the Federal Reserve (Fed), rose 2.0% year over year in September, matching the Fed’s 2% target.
October reports showed a continued slowdown in the U.S. housing market, partly attributable to the reduction in housing affordability from rising mortgage rates. Gains in home prices, represented by the S&P CoreLogic Case Shiller 20-City Composite, slowed for the fourth straight month. Existing home sales fell for the sixth straight month in July, while new home sales decreased for a fourth straight month.
ECB Starts Tapering, Bank of Japan Holds Rates Steady
The Fed didn’t meet in October, but other major central banks gathered during the month. The European Central Bank (ECB) announced October 25 that it would reduce bond purchases to 15 billion euros through December, and will decide at the end of the year whether to end its bond-buying program, based on incoming data and the outlook for inflation. The ECB also left benchmark rates unchanged and reiterated that it will likely leave rates at current levels through summer 2019. The Bank of Japan announced on October 31 that it would maintain its record-low interest rate, which has been in place since January 2016.
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