U.S. economic growth has lately fallen squarely on consumers’ shoulders. Consumer spending likely added about 2.8% to second quarter gross domestic product (GDP) according to the Federal Reserve (Fed) Bank of Atlanta’s GDP forecasting model. At that rate, the consumer’s contribution to GDP would be the highest for any quarter since the end of 2014. Still, when the GDP report is released July 26, we may see that overall growth last quarter was 1.6%, the slowest since the beginning of 2016. Consumer activity has meaningfully lifted growth, but projections show other parts of the economy have withered.
Recent data has hinted a rebound in consumer activity. Our best view of consumer spending’s contribution to economic growth is through control group retail sales, a kind of core reading that excludes some categories. Control group sales have risen for four straight months, the longest streak since the end of 2017. Month-over-month growth in control group sales averaged 0.6% in the second quarter, one of the highest quarterly averages in this economic cycle.
Consumer spending has been primarily supported by a strong U.S. labor market. U.S. companies have added jobs for 105 straight months, by far the longest streak on record. Claims for unemployment benefits have been contained, wages have grown at a healthy 3% clip, and the unemployment rate remains near a cycle low. Fiscal stimulus enacted in 2018 provided an extra boost of income for the consumer through lower tax rates and added tax credits. Other short-term catalysts have propelled consumer activity as well. Oil prices are historically low after a steep sell-off late last year, allowing consumers to allocate more income to discretionary spending. Consumer activity was also weak in the first quarter (perhaps due to trade tensions and a record-long government shutdown), so it is not surprising to see a rebound in the second quarter solely from pent-up demand.
The U.S. consumer provided a solid base for GDP growth in the second quarter, but it did not get much help from other sectors in the economy. Business investment, housing, government spending, trade, and inventories are collectively expected to drag down GDP by about 1.2%, according to Atlanta Fed projections. Output from trade and inventories alone likely stripped around 1.5% from GDP, almost negating their 1.7% boost to growth in the first quarter.
U.S. businesses need to step up at this point in the cycle. We’ve been looking for a pickup in capital expenditures (capex) growth, especially after fiscal stimulus’ implementation. Year-over-year growth in nonresidential fixed investment has averaged 3.9% in this cycle, the second-lowest rate among all expansions since 1970. There was a healthy pickup in business spending in the first half of 2018, but that momentum fizzled as U.S. companies sidelined expansion plans in the face of increasing trade and political
uncertainty. Business investment is especially crucial for growth prospects as the personal income boost from fiscal stimulus wanes over the next few years. Higher capex leads to higher productivity, which directly feeds into higher economic output. Productivity also promotes healthy inflation as it keeps employer costs in check.
All the fundamental pieces are in place for a resurgence in capex, but the chilling effect of uncertainty remains. Trade uncertainty will dissolve with meaningful progress in U.S.-China trade talks. Once there is more clarity on trade, we expect capex to pick up again as companies take advantage of fiscal incentives, record cash piles, and low borrowing costs. Despite slowing growth, the economy has yet to reach its full potential.
We’re encouraged by strength in consumer spending, especially in the face of global headwinds. Still, capital expenditures will need to rebound to extend the expansion.
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- Data provided by LPL Financial.
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