Weak Q117 Real GDP, the Fed and a Trump Tax Cut

The weak Q117 Real GDP Growth is not likely to deter the Fed from pursuing 2-3 rate hikes in the remainder of the year.  The low print reflected a couple of temporary factors, as discussed below.  However, while Real GDP Growth should speed up in Q217, Nonfarm Payroll growth is likely to come in around or below the +178k Q117 average m/m pace.  For next week's April Employment Report, consensus expects +180k m/m Payrolls.  My expectation is around 150k.

The 0.7% (q/q, saar) increase in Q117 Real GDP Growth came in between the 0.5% Atlanta Fed model's estimate and the 1.1% consensus -- in line with my expectations (see prior blog).  The weakness can be attributed primarily to a sharp slowdown in inventory investment after it popped in Q416 (subtracting 1.0% pt from Q117 Real GDP growth) and a temporary drop in consumer spending on heating utilities as a result of the warmer-than-normal winter.  Without these two drags, Q117 GDP Growth would have been about 2.0%.

Real GDP Growth should speed up in Q217.  Consumer spending on utilities will rebound in Q217 as the weather returns to normal.  And inventory investment is not likely to slow as much as in Q117.  However, the pace of inventory investment could remain subdued.  Retail store closings could reduce inventories further.  And, an inventory correction in the motor vehicle sector may very well continue.  The latter appears to be part of the weakness in inventory investment in Q117, as motor vehicle output fell sharply then.

Inflation was high in Q117, but it could just reflect volatility.  The Core PCE Deflator rose 2.0% (q/q, saar) in Q117, but this followed a low 1.3% in Q416.   The y/y was 1.7% -- still below the Fed's 2.0% target.  Note that the March Total and Core PCE Deflator, due Monday, risk falling m/m.  In another report today, the Q117 Employment Cost Index jumped 0.8% q/q.  But, this could be a one-off start-of-year pop.  The y/y moved up for the second quarter in a row.  But, at 2.4%, the y/y is in line with those of other labor cost measures.

The low Q117 Real GDP Growth will probably prompt anti-Trump analysts to blame him and pro-Trump analysts to say it argues for a tax cut.   Neither is correct.  Without the two drags mentioned above Real GDP Growth was slightly above trend.  My view of a tax cut is that it makes sense in the current situation of near full employment if it works to boost trend or potential GDP Growth.  There are two ways this could happen -- /1/ it leads to higher productivity growth  or /2/ it leads to faster labor force growth.  Tax supporters would say that lower corporate tax rates would spur investment spending, which leads to higher productivity growth.  The problem is that the US capital stock is so large that a reasonable pickup in investment spending would not boost the capital stock by much.   Tax supporters also would say that cutting individual tax rates would bring people back into the labor force.  The problem here is that demographics may work against this effect -- which may be measurably small to begin with.