Tuesday, October 09, 2018

Q3 Review: Ten Economic Questions for 2018

by Calculated Risk on 10/09/2018 12:41:00 PM

At the end of last year, I posted Ten Economic Questions for 2018. I followed up with a brief post on each question. The goal was to provide an overview of what I expected in 2018 (I don't have a crystal ball, but I think it helps to outline what I think will happen - and understand - and change my mind, when the outlook is wrong).

By request, here is a quick Q3 review. I've linked to my posts from the beginning of the year, with a brief excerpt and a few comments:

10) Question #10 for 2018: Will the New Tax Law impact Home Sales, Inventory, and Price Growth in Certain States?

My sense is the low end of the housing market will be fine. The Mortgage Interest Deduction (MID) will be capped at interest on a mortgage up to $750,000 instead of $1,000,000, so the lower priced markets will not be hit by the reduction in the MID. There might be some additional taxes for these buyers due to the limits on SALT and property taxes, but this should be minor.

I also expect the high end of the market to be fine. The high end is already doing well even with the MID capped at $1 million. For these buyers, the bigger impact will be the SALT and property tax limitations, but there will be offsets for these buyers due to the lower rates - and these buyers will likely benefit from the corporate tax cuts.  Many of these buyers will also benefit from the changes to the Alternative Minimum Tax (AMT).

It is the upper-mid-range in the certain markets that will probably slow.  This might be in the $750,000 to $1.5 million price range.  These potential buyers probably don't benefit from the AMT or corporate changes, but they will likely be hit by the SALT and property tax limits. 
There isn't any clear evidence of an impact from the new tax law, although many areas  are now seeing a year-over-year increase in inventory - and that suggests that price growth will slow.

9) Question #9 for 2018: Will housing inventory increase or decrease in 2018?
I was wrong on inventory last year (and the previous year), but right now my guess is active inventory will increase in 2018 (inventory will decline seasonally in December and January, but I expect to see inventory up again year-over-year in December 2018).   My reasons for expecting more inventory are 1) inventory is historically low (lowest for November since 2000), 2) and the recent changes to the tax law.
According to the August NAR report on existing home sales, inventory was up 2.7% year-over-year in August, and the months-of-supply was at 4.3 months.  Some areas, like Las Vegas, are reporting inventory up sharply year-over-year in September.    It appears inventory will be up year-over-year this year.

8) Question #8 for 2018: What will happen with house prices in 2018?
Inventories will probably remain low in 2018, although I expect inventories to increase on a year-over-year basis by December of 2018.  Low inventories, and a decent economy suggests further price increases in 2018.

Perhaps higher mortgage rates will slow price appreciation.  If we look back at the "taper tantrum" in 2013, price appreciation slowed somewhat over the next year - but that was from a high level.  In June 2013, the Case-Shiller National index was up 9.3% year-over-year.  By June 2014, the index was up 6.3% year-over-year.

If inventory increases year-over-year as I expect by December 2018, it seems likely that price appreciation will slow to the low-to-mid single digits.
If is early, but the CoreLogic data released last week showed prices up 5.5% year-over-year in August. This was the slowest appreciation in nearly two years.  It appears likely that price appreciation will slow as expected.

7) Question #7 for 2018: How much will Residential Investment increase?
Most analysts are looking for starts to increase to around 1.25 to 1.3 million in 2018, and for new home sales of around 650 thousand.

I also think there will be further growth in 2018. My guess is starts will increase to just over 1.25 million in 2018 and new home sales will be just over 650 thousand.
Through August, starts were up about 7% year-over-year compared to the same period in 2017, and on pace for about 1.3 million this year.  New home sales were also up about 7% year-over-year and on pace for about 640 thousand in 2018.

6) Question #6 for 2018: How much will wages increase in 2018?
As the labor market continues to tighten, we should see more wage pressure as companies have to compete for employees. I expect to see some further increases in both the Average hourly earning from the CES, and in the Atlanta Fed Wage Tracker.  Perhaps nominal wages will increase close to 3% in 2018 according to the CES.
Through September 2018, nominal hourly wages were up 2.8% year-over-year. This is slightly faster than last year, and it appears wages will increase at a slightly faster rate in 2018 than in 2017.

5) Question #5 for 2018: Will the Fed raise rates in 2018, and if so, by how much?
My current guess is the Fed will hike three times in 2018.

As an aside, many new Fed Chairs have faced a crisis early in their term.   A few examples, Paul Volcker took office in August 1979, and inflation hit almost 12% (up from 7.9% the year before), and the economy went into recession as Volcker raised rates.   Alan Greenspan took office in August 1987, and the stock market crashed almost 34% within a couple months of Greenspan taking office (including over 20% in one day!).  And Ben Bernanke took office in February 2006, just as house prices peaked - and he was challenged by the housing bust, great recession and financial crisis.

Hopefully Jerome Powell will see smoother sailing.
The Fed has already hiked three times in 2018, and it now appears there will be four hikes this year.

4) Question #4 for 2018: Will the core inflation rate rise in 2018? Will too much inflation be a concern in 2018?
The Fed is projecting core PCE inflation will increase to 1.7% to 1.9% by Q4 2018.  However there are risks for higher inflation with the labor market near full employment, and new tax law providing some fiscal stimulus.

I do think there are structural reasons for low inflation, but currently I think PCE core inflation (year-over-year) will increase in 2018 and be closer to 2% by Q4 2018 (up from 1.4%), but too much inflation will still not be a serious concern in 2018.
As of August, inflation has moved up to the Fed's target.

3) Question #3 for 2018: What will the unemployment rate be in December 2018?
Depending on the estimate for the participation rate and job growth (next question), it appears the unemployment rate will decline into the high 3's by December 2018 from the current 4.1%.   My guess is based on the participation rate declining about 0.2 percentage points in 2018, and for decent job growth in 2018, but less than in 2017.
The unemployment rate was at 3.7% in September.

2) Question #2 for 2018: Will job creation slow further in 2018?
So my forecast is for gains of around 150,000 to 167,000 payroll jobs per month in 2018 (about 1.8 million to 2.0 million year-over-year) .  Lower than in 2017, but another solid year for employment gains given current demographics.
Through September 2018, the economy has added 1,875,000 thousand jobs, or 208,000 per month. This is  above my forecast, and it appears the economy will add more jobs in 2018 than in 2017 although still below gains for the years 2014 through 2015.

1) Question #1 for 2018: How much will the economy grow in 2018?
It is possible that there will be a pickup in growth in 2018 due to a combination of factors.

The new tax policy should boost the economy a little in 2018, and there will probably be some further economic boost from oil sector investment in 2018 since oil prices have increased recently.  Also the housing recovery is ongoing, however auto sales are mostly moving sideways.

And demographics are improving (the prime working age population is growing about 0.5% per year, compared to declining a few years ago).

All these factors combined will probably push GDP growth into the mid-to-high 2% range in 2018.  And a 3% handle is possible if there is some pickup in productivity.
GDP growth was at 2.2% in Q1, and 4.2% in Q2.  Most estimates suggest growth in the mid to high 3s in Q3.   This would put GDP growth in the low 3s through Q3.

Currently it looks like 2018 is unfolding about as expected, although, employment gains will be somewhat higher than I originally expected.