After rebounding by 30% annualised in the third quarter, we expect a more modest 4.5% gain in GDP in the fourth. But recent data suggest the risks to that forecast could lie to the upside, with investment rebounding rapidly and the September retail sales data showing that the recovery in consumption still carries plenty of momentum. Although the recent negotiations have yielded little progress, there is still a chance of additional fiscal stimulus next year although, even under a Democratic clean sweep of the election, it may arrive later that the markets currently appear to be assuming. Furthermore, the renewed upturn in coronavirus cases in the Midwest highlights that there are still downside risks too, with a further significant rise in cases over the winter months potentially weighing on confidence and raising the prospect of restrictions on activity being reimposed.
- After rebounding by 30% annualised in the third quarter, we expect a more modest 4.5% gain in GDP in the fourth. But recent data suggest the risks to that forecast could lie to the upside, with investment rebounding rapidly and the September retail sales data showing that the recovery in consumption still carries plenty of momentum. (See Chart 1.) Although the recent negotiations have yielded little progress, there is still a chance of additional fiscal stimulus next year although, even under a Democratic clean sweep of the election, it may arrive later that the markets currently appear to be assuming. Furthermore, the renewed upturn in coronavirus cases in the Midwest highlights that there are still downside risks too, with a further significant rise in cases over the winter months potentially weighing on confidence and raising the prospect of restrictions on activity being reimposed.
- Output and activity indicators show the manufacturing recovery still lagging behind.
- Consumption indicators suggest that waning fiscal support has not yet been a major drag.
- Investment indicators show business equipment and residential investment rebounding rapidly.
- External trade indicators reveal that exports are still lagging behind the recovery in imports.
- Labour indicators point to a gradual slowdown in the pace of recovery.
- Inflation indicators imply that the rebound in core inflation has further to run.
- Financial market indicators suggest that hopes of a post-election fiscal stimulus are rising.
Chart 1: Retail Sales (Feb. 2020=100)
- We estimate that GDP rebounded by 30% annualised in the third quarter. The continued strength of consumption suggests the risks to our forecast that GDP growth will slow to about 4.5% in the fourth quarter may lie to the upside (2). Nevertheless, the latest wave of coronavirus infections in the Midwest poses a clear downside risk over the coming months (3). Although deaths remain low, a further significant upturn in hospitalisations would raise the risks of healthcare systems becoming overwhelmed and more severe restrictions on activity being reimposed (4).
- The recovery in manufacturing has stalled, with output more than 6% below its February level and lagging well behind the recovery in retail sales (5). The regional surveys point to a further improvement in the ISM manufacturing index in October, suggesting that production should begin to pick up soon (6).
- In the meantime, in a very unusual trend for this stage of an economic recovery, inventories are looking increasingly lean, with the business inventory-to-sales ratio dropping to a six-year low in August (7).
Chart 2: Real GDP
Chart 3: Daily New COVID-19 Cases & Deaths
Chart 4: Currently Hospitalised & ICU Patients (000s)
Chart 5: Retail Sales & Manufacturing Output (Feb=100)
Chart 6: Regional Surveys & ISM Manufacturing Index
Chart 7: Business Inventory-to-Sales Ratio
Sources: Refinitiv, Johns Hopkins, Covid Tracking Project, CE
- The surprisingly strong 1.9% m/m rise in retail sales in September illustrates that the consumer recovery was still carrying plenty of momentum going into the fourth quarter and provides further evidence that the expiry of the enhanced unemployment benefits at the end of July has not had a significant negative impact (8). We expect consumption growth to slow from nearly 40% annualised in third quarter to a still-strong 7%-8% in the fourth (9).
- Admittedly, the latest upturn in coronavirus cases raises the risk that new restrictions on activity could result in a renewed decline in spending, particularly in the services sector. But the latest high-frequency data suggest that spending on travel, restaurants and accommodation has continued to recover in October (10). There is also no sign yet of any negative impact on consumer confidence (11).
- The continued resilience of personal incomes, which remain above their pre-pandemic level despite the drop in unemployment insurance payments, is another positive sign (12). Furthermore, the still-high personal savings rate suggests that, even in the absence of any further fiscal support after the election, consumption will continue rising gradually (13).
Chart 8: Retail Sales (Feb ’20 = 100)
Chart 9: Real Consumption
Chart 10: High-Freq. Consumption Indicators (%y/y)
Chart 11: Uni of Michigan Consumer Confidence Index
Chart 12: Chg in Personal Income Since Feb. ($trn)
Chart 13: Personal Saving (% of Disp. Income)
Sources: Refinitiv, OpenTable, TSA, STR, Capital Economics
- The rise in underlying capital goods orders and shipments in August lifted them further above their pre-pandemic level and suggests that, after falling by 35.9% annualised in the second quarter, business equipment investment will rebound at a similar pace in the third (14). Survey measures of business confidence also show a dramatic turnaround in the prospects for equipment investment (15), which may partly be explained by the sustained fall in corporate borrowing costs this year (16).
- Other categories of business investment have not staged as rapid a resurgence, with private non-residential construction spending still edging lower and mining investment languishing near its recent lows. That said, the number of active drilling rigs has started to creep higher and the earlier recovery in crude oil prices points to further improvement (17).
- The explosion in housing activity shows few signs of abating, with record-high homebuilder confidence pointing to further gains in housing starts and home sales continuing to surge (18 & 19). Residential investment appears to have rebounded by close to 50% annualised in third quarter and looks set for another outsized gain in the fourth quarter too.
Chart 14: Non-Def. Capital Goods Ex-Air. ($bn)
Chart 15: CEO Confidence & Bus. Equipment Investment
Chart 16: Corp. Bond Yield & Bus. Equipment Investment
Chart 17: Crude Oil Price & Drilling Rigs
Chart 18: Housing Starts & Homebuilder Confidence
Chart 19: New & Existing Home Sales (000s Ann.)
- The further widening in the trade deficit to a 14-year high of $67.1bn in August, from $63.4bn, came as the rebound in imports continued to outpace the recovery in exports (20). While real goods imports are now back above their February level, exports are still 10% below their pre-pandemic peak (21).
- That gap isn’t a huge surprise when we already know that domestic manufacturing production is lagging well behind the recovery in retail sales. While imports of consumer goods are nearly 15% higher than they were in February, exports still show broad-based weakness, with the two key categories of industrial supplies (mainly petroleum) and capital goods (principally aircraft) exerting the biggest drags (22).
- The latest survey evidence suggests goods exports will continue to recover over the coming months (23), while the recent depreciation of the dollar should provide some additional support (24). Nevertheless, ongoing weakness in US specialisms like commercial aircraft and tourism services suggests that it will take much longer for overall exports to stage a full recovery (25)
Chart 20: Trade Balance ($bn)
Chart 21: Real Goods Trade ($bn, 2012 Prices)
Chart 22: Goods Exports & Imports (% Chg. Feb to Aug)
Chart 23: ISM Export Orders & Goods Exports
Chart 24: Real Dollar TWI & Goods Exports (%y/y)
Chart 25: Selected US Exports ($bn)
- September’s weaker-than-expected payrolls data show the labour market recovery entering a slower phase. Admittedly, the below-consensus 661,000 increase was in part due to a fall in government education employment, as the new school year shifted largely online (26). But private sector industries also experienced a slowdown, with employment in the leisure industry, including accommodation & food services, still nearly 25% below its February level (27).
- The headline unemployment rate dropped to 7.9% in September, from 8.4% (28). But that wasn’t as positive as it looked, as it mainly reflected a 695,000 fall in the labour force, which remains 4.4 million lower than it was before the pandemic (29).
- Initial jobless claims have levelled off in recent weeks, remaining not far below one million per week (30). But the wider evidence suggests they are painting an overly pessimistic picture of labour market conditions. The jobs hard-to-fill index in the latest NFIB Survey rebounded to a level normally consistent with an unemployment rate of only 4%. Meanwhile, the rapid recovery in firms’ compensation plans suggests that underlying wage growth will remain close to 3% (31).
Chart 26: Non-Farm Payroll Employment (Mn)
Chart 27: Chg in Non-Farm Payroll Emp’t (Feb – Sep, %)
Chart 28: Unemp. & Involuntary Part Time Rates (%)
Chart 29: Labour Force (Mn)
Chart 30: Weekly Jobless Claims (Millions)
Chart 31: NFIB Compensation Plans & Wages & Salaries
- The more modest monthly rise in core consumer prices left core CPI inflation unchanged at 1.7% in September (32), but the three-month annualised rate was still unusually elevated at 4.9% (33). Moreover, core inflation on the Fed’s preferred PCE measure has staged an even sharper rebound in recent months (34).
- With core services inflation still muted, the rapid recovery has been driven entirely by a resurgence in goods prices (35). A big part of that can in turn be explained by used vehicle prices which, after surging by 5.4% in August, rose by 6.7% in September, the biggest monthly gain since 1969.
- The latest auction price data suggest that used vehicle prices specifically will not continue to rise at that rapid pace for much longer (36). But there is still plenty of scope for unusually low inventory levels to put upward pressure on other goods prices, with new vehicle prices looking at risk of a renewed upturn (37).
Chart 32: CPI Inflation (%)
Chart 33: Core CPI
Chart 34: Core Inflation (%)
Chart 35: Core CPI Inflation (%)
Chart 36: Used Vehicle Prices indices (%m/m)
Chart 37: Auto Inventories & New Vehicle Prices
Sources: Refinitiv, Black Book
- Part of the weakness in services inflation can be explained by the sharp slowdown in rent inflation, which the still-high unemployment rate suggests has further to run (38). But that could be offset by a further rise in medical care services inflation, with the PCE measure recently hitting its highest level in a decade (39).
- More generally, the latest survey evidence suggests that services inflation will rebound over the coming months (40). That would be consistent with the rapid recovery in selling prices reported by small businesses (41), and with the ongoing supply constraints for many firms in consumer-facing sectors.
- The earlier upturn in household inflation expectations appears to be moderating (42), potentially driven by the easing of price pressures at grocery stores. But market-based measures of breakeven inflation compensation have held broadly steady, with the five-year/five-year forward rate now slightly above its pre-pandemic level (43).
Chart 38: Unemployment Rate & CPI Rents
Chart 39: Medical Care Services Inflation (%)
Chart 40: ISM Prices Paid & CPI Services
Chart 41: NFIB Selling Prices & Core CPI Inflation
Chart 42: Household Inflation Expectations (%)
Chart 43: Breakeven Inflation Compensation (%)
- The gradual rise in the 10-year Treasury yield in recent weeks appears to reflect growing hopes that a Democratic clean sweep of next month’s elections will result in a major fiscal stimulus early next year (44). Stimulus hopes appear to be benefiting the stock market too and, while it would be a bit of a stretch to say that stocks are tracking the Democrats’ odds of victory, it is nevertheless notable that the rising chances of a ‘blue wave’ in recent months have coincided with a continued recovery in the S&P 500, despite Joe Biden’s plans to raise corporate taxes (45).
- The Fed might step in if long-term yields rise much further, and there is plenty of scope for Treasury purchases, which have been running at about $20bn per week, to be ramped up again (46). That said, the still-low level of corporate bond yields highlights that overall financial conditions remain pretty loose (47).
- The dollar has continued to lose ground, although in nominal trade-weighted terms it is no lower than it was at the start of the year (48). The biggest winner over the past month has been the Chinese renminbi (49). That could reflect hopes that a President Joe Biden would take a less aggressive approach to trade policy, but the main driver has probably been the relatively rapid recovery in China’s economy.
Chart 44: Treasury Yields (%)
Chart 45: Election Odds & S&P 500
Chart 46: Fed’s Weekly Treasury Purchases ($bn)
Chart 47: Corporate Bond Yields (%)
Chart 48: US Fed Trade-Weighted Dollar Index
Chart 49: Change in Dollar (% m/m)
Sources: Refinitiv, PredictIt
Paul Ashworth, Chief US Economist, email@example.com
Andrew Hunter, Senior US Economist, firstname.lastname@example.org
Michael Pearce, Senior US Economist, +1 646 583 3163, email@example.com
Oliver Byrne, Research Assistant, firstname.lastname@example.org