Stocks should continue to rally this week, lifted by strong corporate earnings and the Q417 GDP report (due Friday). The Government shutdown is likely to be a neutral factor at worst, since the main issue of contention -- "dreamers" -- is not market relevant.
A strong GDP report would be a negative for Treasuries, as it would raise the risk of higher inflation ahead. Indeed, last week's survey data on longer-term inflation expectations edged up. The combination of a higher inflation risk and strong economic growth almost guarantees that the Fed will hike 25 BPs at the March FOMC meeting. The Fed is not likely to hike rates at the January 31 FOMC meeting, though, as it remains committed to a gradual approach to tightening and it just tightened in December.
Expectations are for another quarter of GDP growth with a "3" handle. Consensus for Q417 Real GDP Growth is 3.0% (q/q, saar), while Atlanta Fed and NY Fed models project 3.4% and 3.9%, respectively. For the full 2017, the Q4/Q4 growth rate would be between 2.6% and 2.9%, based on these forecasts. It has the potential to be the best growth rate since the recession (see table below).
The most important fall-out from the GDP report will be whether it pushes the Fed and Street Economists to raise their 2018 GDP forecasts, particularly if they do so to above 3%. Upward revisions would underscore the better profit outlook for stocks. Greater-than-3% full-year forecasts may be expecting too much from forecasters, however, since it is very early in the year. For example, NY Fed President Dudley said in a speech last week that he had raised his 2018 forecast by 0.5 percentage point to 2-1/2 to 2-3/4%. Nevertheless, a Q417 GDP composition that shows strong Final Sales and a decline in or very low Inventory Investment would be viewed as pro-growth and possibly as raising the risk of a "3" handle on 2018 GDP Growth.
The second important fall-out from the GDP report would be if it boosts forecasts of trend productivity growth. A higher trend in productivity growth is a positive for the overall standard of living. It also works toward solving long-term problems in the outlooks for Social Security, Medicare and Federal Deficit, as well as keeping inflation low. The Q417 Productivity data will be released on February 1. At this point, it looks like the Nonfarm Output portion of Q417 GDP needs to be well above 4% to get 1+% productivity growth for the quarter. The higher workweek and surge in self-employed people may have resulted in Total Hours Worked rising 3+%. Productivity Growth is defined as Output Growth less Total Hours Worked Growth.
(Q4/Q4 Growth Rate)
Real GDP Growth Nonfarm Productivity **
2017 2.6-2.9 1.5*
2016 1.9 0.9
2015 2.0 0.7
2014 2.7 0.4
2013 2.7 1.6
2012 1.3 0.1
2011 1.7 0.0
2010 2.7 1.8
2009 -0.2 5.7
* annualized productivity growth over the first 3 quarters of 2017.
** Productivity tends to be strong at the start of a recovery, so the high 5.7% 2009 pace is not indicative of trend. The 0.8% average between 2010 and 2016 is more indicative of the recent trend. It is below the 1.0-1.5% pace that was considered the US longer-term trend prior to the recession.
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