St. Louis Fed: U.S. economy to see 3% GDP expansion in 2018

A consensus of Federal Reserve forecasters now expect the U.S. economy to expand at an annual rate of 3% in 2018 following the strong reading in the second quarter and increasing concerns that some broad-based economic indicators imply weaker growth.

In a recent report by the St. Louis Federal Reserve Eighth District, economist Kevin Kliesen said the near doubling of the real Gross Domestic Product (GDP) growth rate in the second quarter will help the U.S. economy close out the remainder of the year well ahead of last year’s tepid 2.3% expansion.

“The U.S. economy roared ahead in the second quarter of 2018 after increasing at a modest rate in the first quarter,” Kliesen wrote in his recent forecast. “Economic conditions have been fueled by strong corporate profits, healthy financial market conditions, and accommodative monetary and fiscal policies. If these trends persist, buoyant economic and labor market conditions are likely over the second half of the year.”

Kliesen’s report follows the strong “advance” GDP reading of 4.1% on July 27 by the Bureau of Economic Analysis (BEA), which has been highlighted by President Donald Trump’s boast that the quarterly reading was a sign that the U.S. economy is headed into uncharted growth territory.

Next week, economic watchers will get a clearer picture of the second quarter expansion when the BEA releases its “second” reading on Wednesday, Aug. 29. The “advance” estimates are released near the end of the first month of each quarter and are based on source data that are incomplete or subject to further revision by the source agency. Second and third estimates are based on more detailed and more comprehensive data as they become available.

The second quarter acceleration was the fastest economic expansion since a GDP spike of 5.2% in the third quarter of 2014. It was largely due to strong consumer and government spending, along with a spike in U.S. exports ahead of expected retaliatory tariffs from China, the European Union and U.S. allies, BEA data shows.

The brisk second quarter growth was also well ahead of the 2.2% expansion in the first quarter. That three-month period was modestly stronger than both the consensus of blue chip forecasters of 3.9% and well ahead of the St. Louis Fed’s own Economic News Index at 3.4%.

INTEREST RATE HIKES AHEAD
The St. Louis Fed forecaster also noted that the Federal Open Market Committee (FOMC) is likely to continue to increase interest rates gradually for the remainder of 2018 despite headline inflation moderating in the second quarter. After increasing at a 2.5% annual rate in the first quarter mainly due to rising energy prices, inflation slowed to a flat 1.8% in the second quarter.

“In response to strengthening economic conditions and rising price pressures, the FOMC indicated that further gradual increases in its policy rate are likely,” Kliesen said. “However, policymakers and economists are carefully monitoring recent international developments.”

The St. Louis Fed’s own inflation forecasting model employs a broad array of prices, both domestic and foreign, to predict prices over a 12-month period. The latest forecast projects that inflation will slow from 2.2% in July 2018 to about 1.75% in July 2019.

“This forecast is consistent with recent developments: a strengthening U.S. dollar, some softening in the global economy, weaker oil and commodity prices, and stable inflation expectations. The model continues to indicate a small probability that headline inflation will accelerate past 2.5% over the next 12 months,” said the 8th District forecaster.

Kliesen’s report also highlighted the growing concern that the many employers across the U.S. are having a difficult time filling open positions despite the nation’s low jobless rate of 4% and the brimming labor pool that is adding nearly 190,000 workers each month. Despite those concerns, Kliesen said the strong demand for labor has fueled a modest growth in wages and compensation. He also said most U.S. forecasters expect continued solid gains in consumption and business fixed investment, a modest rebound in residential fixed investment, and some inventory rebuilding, offset to some extent by weaker growth of net exports due to a larger trade deficit.

“Forecasters also predict that inflation will remain near the Fed’s target rate,” said Kliesen. “Solid growth and low inflation will help maintain healthy labor market conditions, though with perhaps some modest upward pressure on interest rates.

RECESSION PREDICTION
The St. Louis Fed’s forecast did not break out economic data for the 8th District, which includes all or parts of seven Midwest states, including Arkansas, Illinois, Indiana, Kentucky, Mississippi, Missouri and Tennessee. However, St. Louis Fed President James Bullard, who sits on the influential FOMC panel that sets U.S. monetary policy, ramped up concerns this week about the possibility of a so-called “yield curve inversion.”

On Monday, the Fed contrarian repeated his warning to fellow FOMC members that if the nation’s central bank continues its higher projected path for interest rate hikes, then the U.S. economy could be headed for a recession. Bullard’s recent speech revisits his cautionary warning in Little Rock in April that if U.S. monetary policymakers continue the course of hiking short-term U.S. interest rates, the U.S. economy could be put at risk.

“Since then, events have transpired that have flattened the yield curve further, and imminent yield curve inversion in the U.S. has become a real possibility,” Bullard said Friday in a speech to the Glasgow-Barren County Chamber of Commerce in Kentucky. “There is a material risk of yield curve inversion over the forecast horizon about 2 ½ years if the FOMC continues on its present course. Yield curve inversion is a naturally bearish signal for the economy. This deserves market and policymaker attention.”

Bullard’s speech also noted that the St. Louis Fed’s policy rate recommendation is flat over the forecast horizon, meaning no planned interest rate hikes provided the economy continues to perform as expected. Similar to the Fed forecast, top Wall Street economists last week predicted 3% U.S. GDP growth in 2018 and a weaker 2.4% expansion in 2019.