The end of the summer has been chaotic for the US economy. On 30 August, the Bureau of Economic Analysis (BEA) released its second estimate of second-quarter Gross Domestic Product (GDP) growth, an upward revision of 0.4 percentage point to 3.0% — the fastest pace in more than two years. However, on 1 September, the Department of Labor's employment situation summary showed a meager 156,000 payroll jobs added to the economy along with an increase in the unemployment rate to 4.4%. August also brought a major natural disaster in the form of Hurricane Harvey, which made landfall near Houston, TX, the nation's fourth-largest city, on the 26th, and whose subsequent rainfall brought unprecedented flooding which dwarfed all previous records. And in the background, the first of seven rounds of the NAFTA (North American Free Trade Agreement) renegotiation talks began on 16 August.
Watch my interview with CGTN America where I talk about a number of these issues.
So how is the economy really doing?
On the whole, the US economy is showing strength. The vigorous 3.0% growth rate of second-quarter GDP, which followed a mediocre 1.2% in the first quarter, brought the highest-profile "hard" economic indicator in line with the "soft" ones like consumer and small business confidence which have been projecting strength and optimism from consumers and small business owners since late 2016. Consumers are doing the bulk of the heavy lifting, as they have for much of the recovery, but nonresidential fixed investment and corporate profits also made a solid showing. So, what about the employment report?
As it happens, the August payroll estimate is the least trustworthy of the 12 monthly estimates. Indeed, since 2000, the October report has raised the initial August estimate by an average of 55,000 jobs. 14 of the 17 August revisions since 2000 have been upward. In 2011 and 2012, October's revisions increased the August totals by 104,000 and 96,000. The bottom line is that the initial payroll estimates are so imprecise, it is best to wait for the second or third reading—particularly for this month's report. Instead, trends such as month averages or year-ago changes can be instructive. These portray a mixed picture of the labor market. The 12-month average payroll gain, 175,000, indicates that job growth remains solid, and the 0.5-percentage-point drop in the unemployment rate in the past 12 months, combined with steady job growth, suggests that the unemployment rate may fall further still. On the other hand, the year-over-year percentage gain in average hourly earnings, 2.5%, compared with a 2.1% rise in the consumer price index, indicates that real wage gains remain slow. Moreover, participation rates remain historically low for key demographic groups.
How about Harvey?
One key point is that the impact of Hurricane Harvey was not felt in the August employment report. This is a function of the survey methodology; the reference period is the pay period that contains the 12th of the month. If events like a hurricane impede an employee's ability to work, average weekly hours may be reduced, but for a catastrophic event to reduce the employment estimate, an employee has to be out of work without pay for the entire pay period—generally two weeks. However, while this did not occur for the August report, it will very likely affect September's numbers because many Texans will be off the payrolls during the entire payroll period.
On the GDP front, Harvey will hurt near-term growth and increase the volatility of growth in the third and fourth quarters. Loss of life, damaged infrastructure (especially in the energy and chemicals sectors), and disrupted businesses will take a huge toll on the devastated areas. On the other hand, rebuilding efforts will boost growth when they are able to get underway. Given what we know now, IHS Markit expects that growth in the third quarter—which was previously estimated at around 3.5%—will be cut by 0.5–0.6 percentage point. Fourth-quarter growth—previously estimated at around 2.4%—will likely be bumped up by a few tenths of a percentage point.
What does this mean for the Fed?
The Federal Reserve is likely to discount the August employment report as it continues with plans to shrink its balance sheet in September and raise rates again in December. And although Hurricane Harvey's interruption to production is likely to result in a short-term spike in energy prices, the Fed is likely more concerned about stubbornly slow core consumer price inflation—which excludes food and energy products — than by this spike. One risk is that if NAFTA negotiations result in the wholesale dissolution of the trade agreement—an event we consider unlikely—it would result in damage to the US economy and labor market as US and Mexican businesses maintain strong bilateral trade flows.
If nothing else, this fall will at least be interesting.
Chris G. Christopher, Jr. is the Executive Director of US Macro, Global Economics, and Consumer Markets for IHS Markit.
Posted 6 September 2017