United States / Spotlight Reports
Q3 Macroeconomic Update: Rising Employment, Slowing Investment

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by Viraj D'Costa, Robert Miles, Brian Sayler and Chrystalleni Stivaros
Dec 18 2017

The US economy experienced strong growth during the third quarter of 2017, as robust growth in nonresidential fixed investment and rising levels of Personal Consumption Expenditure (PCE) substantially offset declines in residential fixed income. Moreover, the US dollar depreciated slightly during the three-month period, causing US-manufactured goods to become more affordable for foreign consumers, which bolstered US export activity while limiting the volume of goods imported to the United States. Record-setting performances by the S&P 500 and other financial measures also contributed to US economic growth during the quarter, with major technology companies, such as Apple, Facebook and Google, fueling growth in US equity markets. Overall, revised data estimates from the Bureau of Economic Analysis (BEA) indicate that inflation-adjusted Gross Domestic Product (GDP) increased at a seasonally adjusted annualized rate of 3.3% during the third quarter of 2017, outpacing annualized growth of 3.1% during the previous three-month period.

In line with improving economic conditions, the US labor market expanded during the third quarter, with industries in the food services, professional services and healthcare sectors experiencing particularly strong job growth. These positive economic trends also included rising levels of business sentiment, which led to a strong uptick in the number of year-to-date initial public offering filings (IPOs). Following this strong economic performance during the third quarter of 2017, the Federal Reserve (the Fed) is expected to raise the federal funds rate an additional quarter point in the coming months, which would represent the fifth interest rate hike since December 2015.

Consumer spending and labor

From the start of July through September, the US economy added 364,000 nonfarm jobs. Moreover, according to the Bureau of Labor Statistics (BLS), an additional 261,000 nonfarm jobs were added in October; typically, job gains over 150,000 per month are seen as growth in the labor market. Service-based industries, in particular, experienced large increases. Specifically, in October, 89,000 jobs were added in food services, 50,000 jobs added in professional and business services and 34,000 jobs in healthcare and social assistance (16,000 of which arose from ambulatory services). However, in the same month, employment in the mining sector declined by 2,000 jobs, and telecommunication services lost 5,000 jobs. As a result, the unemployment rate fell to 4.1%, a marginal decline from 4.2% in September. Notably, the last time the unemployment rate was as low as 4.1% was in August of 2000. Though the unemployment rate remains below the natural rate (indicating a tightening in the labor market), the number of part-time workers remains above prerecessionary levels. According to the BLS, in October, there were 4.8 million part-time workers and another 524,000 discouraged workers.

unemployment rate

The labor force participation rate (LFPR) has steadily declined over the past decade. In the third quarter of 2007, the LFPR averaged 65.9%. Comparatively, in the third quarter of 2017, the LFPR averaged 63.0%. This figure dropped even further to 62.7% in October. Demographic reasons, rather than economic ones, affect the LFPR. The retiring baby-boomer generation, as well as individuals staying in school longer, inversely affect labor force participation. Furthermore, according to BLS data, real average hourly earnings in October decreased 1 cent from September to $26.53. Despite this slight decline, however, average hourly earnings did increase 2.4% year-over-year. The upward trend of average hourly earnings has encouraged an increase in consumer spending. The rises in employment and wages are an indicator of economic growth, strengthening the case for interest rate hikes by the Fed in the near future.

To monitor inflation, the Fed closely follows the Personal Consumption Expenditures (PCE) survey. PCE showed a strong third quarter, increasing 1.0% in September, 0.1% in August and 0.4% in July. Specifically, PCE increased $76.0 billion in September: $21.6 billion from services, $58.9 billion from durable goods and $8.4 billion from nondurable goods. Furthermore, the Personal Consumption Expenditures Price Index (PCEPI) rose 0.4% in September and 1.6% year-over-year. Hence, inflation is still below the Fed’s target rate of 2.0%. Nonetheless, due to the tight labor market and upward trending wages, inflation is expected to rise closer to the target rate in the near-to-medium future.

Fixed investment and commercial loans

While private fixed investment continued to exhibit growth in the third quarter of 2017, its rate of expansion slowed. According to the BEA, gross private domestic investment (seasonally adjusted and chained 2009 dollars) increased 2.4% in the third quarter. This represents a significant deceleration from 3.2% in quarter two and 8.1% in quarter one. This reflects diverging trends in residential and nonresidential investment, as nonresidential fixed investment has continued to grow while residential has fallen.

According to the BEA, residential investment declined 5.1% and nonresidential investment increased 4.7% in the second quarter of 2017. Within the nonresidential portion of fixed investment, the expansion of investment in equipment has driven growth, whereas investment in structures fell sharply. The level of nonresidential activity has been expanding throughout 2017, partially due to a rebound from the previous year’s declines. Overall, demand for investment in the area has been supported by strong economic activity but has still decelerated throughout the year.

Residential investment trends have told a different story entirely. New housing permits in September fell a significant 4.3% from September 2016. Moreover, new year-to-date permits, when measured at a seasonally adjusted annualized rate, have fallen 6.5%. When the six-month moving average is considered, new permits have undergone a clear reversal from previously rapid growth over the past five years. The moving average indicates that new home demand has slowed substantially, causing residential investment to decline during the second quarter.

The movement of commercial and industrial fixed investment is representative of momentum in the economy. As business sentiment has strengthened and consumer spending remains strong, this has lead to strong purchasing activity both in new machinery and increased inventory. However, while fundamental demand factors for residential demand have remained strong, the growth cycle appears to have peaked. The successive quarters of poor performance suggest that much of the demand for new residential construction has already been satiated.

Financial markets, interest rates and trade

Merger and acquisition (M&A) activity and IPOs continued to grow over the third quarter of 2017. As of the end of November, year-to-date IPO filings had grown over 60.0% from last year’s total. Such a rebound was expected, given that M&A and IPO activity tend to decline during presidential election years, as companies put off major investments until the new administration’s likely policy stances are known. Similarly, equity markets mirrored the improvements to business sentiment, with the S&P 500 once again breaking all-time highs as companies from the technology sector such as Apple, Amazon and Facebook drove growth.

trade-weighted index

Even with positive activity within equity markets, demand for fixed-income investment vehicles grew through the third quarter and has continued its trajectory through today. Some of this is explained by the relative strength of the US economy when compared with other actors on the global stage. A brighter economic outlook for the United States, coupled with three successive interest rate hikes in 2017 alone, has increased demand for US securities, driving yields downward.  Currency markets followed a different trajectory during and beyond the third quarter of 2017, as the dollar’s post-presidential election gains were almost entirely erased. Indeed, the trade-weighted index, which measures the strength of the US dollar against the currencies of several major US trading partners, has fallen from its peak of 103.2 index points at the end of 2016 to 96.9 at the end of November 2017. This decline has caused US-manufactured goods to depreciate relative to their foreign competitors, making US goods more attractive to foreign consumers. The weakening dollar, coupled with modest growth in consumer spending, also led to a limited narrowing of the US trade deficit