Economic Report: Nov. 2, 2015

The U.S. economy slowed in the third quarter, growing just 1.5 percent after rebounding more strongly by 3.9 percent in the second quarter. While this was mostly in line with consensus expectations, the easing in real GDP growth for the quarter mainly reflected reduced inventory spending and a continued drag from net exports. Indeed, the pullback in inventories alone reduced real GDP by 1.44 percentage points in the third quarter as businesses did not need to replenish their stockpiles as much as desired. For manufacturers, this report was a mixed bag, with modest growth in consumer spending on goods, but international demand sapped by the strong dollar and weaknesses abroad. Output is likely to be 2.2 percent for 2015 as a whole, essentially maintaining the more sluggish pace of growth in recent years, and yet, on the positive side, economic growth remains modest overall. The current outlook is for 2.5 percent growth in 2016.

There were three manufacturing reports released last week, with each indicating persistent weaknesses in terms of demand and production. New durable goods orders declined for the second straight month despite decent growth in motor vehicles and parts sales. Nondefense capital goods spending excluding aircraft, which is often referred to as “core capital goods,” fell 1.6 percent and 0.3 percent during the past two months. This suggests lower investment spending overall for the sector. At the same time, there was contracting sentiment once again in the Dallas and Richmond Federal Reserve Bank manufacturing surveys, although each also had some notable signs of progress to report. Texas manufacturers, many of whom are heavily dependent on the energy sector, experienced declining sales in October, but output, shipments and hiring picked up a little for the month. Meanwhile, respondents to the Richmond survey noted some stabilization in new orders, with declines in overall activity slowing a bit in October. Manufacturing firms continue to cite a number of challenges, but they also remain somewhat optimistic in their outlook.

At the consumer level, Americans are also cautious in their assessments of current and future economic conditions. Confidence levels remain subpar, reflecting negative economic headlines weighing heavily on the minds of those individuals completing surveys. The Conference Board’s measure of confidence declined sharply in October, erasing the gains in the past two months, on renewed worries about job market growth. Similarly, the University of Michigan revised its sentiment index lower from an earlier estimate, with confidence remaining well below more upbeat assessments seen just a few months ago. These surveys achieved pre-recessionary highs earlier in the year, but there have been increased anxieties since then that have weakened confidence. This perhaps helps to explain why personal spending slowed in September to its lowest rate since June. Total wages and salaries in the manufacturing sector edged lower for the month, but the longer-term trend remained positive. On a year-over-year basis, personal income and spending both continued to grow modestly.

The Federal Reserve chose not to begin the process of raising short-term interest rates at its October Federal Open Market Committee (FOMC) meeting, as expected. In its statement following the conclusion of the meeting, the Federal Reserve wrote, “The Committee continues to see the risks to the outlook for economic activity and the labor market as nearly balanced but is monitoring global economic and financial developments.” Indeed, the FOMC will be looking for signs of stronger growth in the economy between now and its next meeting, which is scheduled for December 15–16. The Federal Reserve has indicated in the past that it would like to begin increasing rates by year’s end, and that meeting will be its last opportunity to do so this year. I continue to feel that the Federal Reserve will indeed increase short-term rates by 25 basis points in December despite economic headwinds, particularly in the manufacturing sector, and repeated calls by those in the financial markets to wait until 2016 to act.

After sluggish numbers in previous months, we will be looking for signs of a rebound in manufacturing activity and hiring in next week’s reports. This morning, the Institute for Supply Management will release the Manufacturing Purchasing Managers’ Index data for October, with some hope that the sector has improved upon being essentially stagnant in September’s headline data. Likewise, manufacturers have hired essentially no net new workers over the past eight months, making the October jobs report due out on Friday more important. Nonfarm payroll growth was also soft in September. Beyond those two statistics, other reports to watch next week include the latest figures on construction spending, factory orders and shipments, international trade, productivity and vehicle sales.