The U.S. economy grew at a 2.6 percent growth rate during the final three months of 2018 on the back of a 2.8 percent increase in personal consumption bolstered by a blowout 5.9 percent rise in purchases of durables and an unsustainable buildup in inventories, in addition to a 13.1 percent increase in intellectual property investment. The Bureau of Economic Analysis incorporated a benchmark revision to employment and pay for the third quarter, which resulted in an increase of $13 billion in annualized income that translated to a modestly improved pace of spending in contrast with that indicated by the monthly data.
Given the questions surrounding the reliability of the estimates on consumption and business investment, this is a fascinating report. In many ways the outsized increase in outlays on software, research and development, entertainment, literary and artistic originals makes this a very “new economy” GDP report in contrast with the large declines in residential investment and structures. While we would not be surprised to observe downward revisions to business investment in the estimate given the outright weakness in industrial production and durable goods data through the end of 2018, overall growth remains roughly 0.7 percent above trend, which is not sufficiently strong enough to cause the Fed Reserve to lose patience on its path of policy.
On a year-ago basis, the economy grew at 3.1 percent, while real final sales increased at 2.5 percent and final sales to domestic purchasers increased at a 2.6 percent pace. Although growth appears to be roughly 0.7 percent above the long-term trend of 1.8 percent, this pace is not sufficiently strong enough to dislodge the Fed from its current policy stance. This will provide somewhat of a cushion to the economy through the first six months of 2019, as businesses adjust to the damage wrought by the government shutdown, the disruption of cash flows linked to trade tensions and financial volatility. The declines of 4.2 percent in spending on structures and 3.5 percent in outlays on residential investment, along with concern regarding the pace of growth in the current quarter, will likely keep the Fed on hold with respect to interest rates at its March meeting.
Inside the fourth quarter report was solid data across the board: Government consumption was up 0.4 percent, driven by a 6.9 percent increase in outlays on defense. The drag on growth from imports did increase, although not as badly as we anticipated, based on the data. Imports increased at a 2.6 percent pace, while exports advanced by 1.7 percent. The increase of $97.1 billion in inventories will provide a headwind for growth in the current quarter.
Looking forward, once the inconsistencies in the GDP report and the monthly durables are reconciled, the focus for investors should be on growth during the first six months of 2019. In our estimation, growth in the current quarter, which fully captured the government shutdown, the spillover of financial volatility into the real economy and the lagged impact of trade tensions, has slowed to just above 1 percent. It is difficult to build a case where households repeat outlays on durable spending in the current quarter; the federal government increases defense spending at the same rate.