The U.S. economy grew at a solid pace in the fourth quarter, boding well for the outlook of this year and next.
According to the delayed release of GDP data, the economy grew by 2.6 percent in the fourth quarter (after adjustment for seasonality and inflation, and computed at a compound annual rate).
The Federal Reserve currently expects little change in policy in the coming months, followed by mild increases.
The U.S. economy grew at a solid pace in the fourth quarter, boding well for the outlook of this year and next. According to the delayed release of GDP data, the economy grew by 2.6 percent in the fourth quarter (after adjustment for seasonality and inflation, and computed at a compound annual rate). Although lower than the third-quarter growth rate, it's in line with the average of the last two years and better than preceding years. Despite gloomy headlines - and stock market performance - at the end of the year, it turns out that the economy was just fine.
This growth came even though consumers were a bit conservative, having calmed down compared to the middle of 2018. The latest surveys show consumer attitudes deteriorated during the government shutdown but recovered thereafter. With solid job growth and continued wage gains, consumers will increase their spending at a moderate pace in 2019 and 2020, with some upside exuberance possible.
Businesses bumped up their spending on equipment and software, as well as intellectual property development, last quarter. Capital spending had grown rapidly just after the tax reform of a year ago, then decelerated in the second and third quarters of 2018. Now companies are back in expansion mode. The tax changes help, as does continued need to add capacity, plus the benefits of automation and robotization in the continuing tight labor market. Look for continued gains, limited by some supply constraints on the hardware needed for more automation.
Housing construction dropped last quarter, as it had throughout 2018. As I noted in Housing Forecast: Not A Bubble In 2019, "I expect small declines in new housing construction in the coming years, but no bust." Two factors will depress new construction this year and next. First, slow population growth. Last year's increase in U.S. population was the lowest since 1937, significantly depressed by low foreign immigration into the country. Second, higher mortgage rates preclude some families from buying a home at this time. Neither of these will reverse themselves anytime soon.
Foreign trade was not a big factor in last quarter's economic growth, with both exports and imports growing at about the same pace. This sector is uncertain now, with European economies mostly decelerating and businesses not sure what Brexit will mean, on either side of the English Channel. China's economic growth is slowing but not cratering, though we distrust the country's statistics. Trade policy, of course, is highly uncertain, but it seems a good bet that President Trump will cut a deal with China that avoids disaster.
The final part of the GDP calculation is government spending. Federal spending decelerated a good bit in the fourth quarter. (Keep in mind that the GDP calculation does not count transfer payments such as Social Security). State and local government spending actually dropped a hair. All government spending is likely to be a bit stronger in the coming quarters.
The demand side of the economy will be in a good shape in 2019. The supply side will struggle to keep up. Labor is in tight supply, and many of the people being hired were rejected in past years. They will eventually be productive workers, but it will take a while. The overall productivity trend has been low growth in recent years. Greater use of machinery, computers and software will boost output per worker, but the pace of productivity growth will be restrained until the new workers hired in recent years come up to speed.
With the demand side of the economy brighter than the supply side, look for rising prices in many areas. The Federal Reserve currently expects little change in policy in the coming months, followed by mild increases. I bet it will get nervous as more data come out about inflation, and thus I expect more increases in interest rates over the course of 2019 and 2020.
It's a good, solid economic forecast.
Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.