This piece was originally published in the September 2018 issue of electroindustry.

Don Leavens, PhD,  Vice President and Chief Economist, NEMA

According to the Bureau of Economic Analysis second-quarter GDP advance estimate released July 27, 2018, economic output grew at a 4.1 percent annual rate from the previous quarter.

Positive consumer spending, net exports, nonresidential fixed investment, and government spending offset a drag from imports, a contraction in residential investment, and an inventory drawdown. Compared to the same quarter last year, GDP was 2.8 percent higher in the second quarter. In addition, the BEA revised their estimate for first quarter GDP to 2.2 percent from 2.0 percent.

The near doubling in the economic growth pace is partly attributable to factors that are expected to fade over time. For example, a surge in soybean exports ahead of Chinese tariffs helped exports to exceed imports enough to add one percentage point to GDP growth in the second quarter. Also, tax cuts likely helped to spur the jump in consumer spending growth from 0.5 percent in the first quarter to 4.0 percent in the second quarter.

An anticipated decline in soybean exports and the unlikely prospect of additional tax cuts suggest economic growth will fall back in the third quarter to a growth rate closer to 3.0 percent.

While second quarter growth was the strongest since the third quarter of 2014 during the height of the oil extraction boom, it is likely not a sustainable pace.

Given continued weakness in labor force productivity and growth, output growth at 4 percent would eventually precipitate a bout of accelerating inflation. To guard against such an outcome, the Federal Reserve has set course to raise rates gradually to transition monetary policy from being unusually accommodative (easy) to being neutral. Historically, such transitions have often led to recessions as rising interest rates depress asset prices and expose weak investment strategies, particularly if the Fed overshoots its neutral interest rate target.

Compounding matters, recent U.S. trade policy maneuvers are raising uncertainty for businesses contemplating investment decisions as the viability of global supply chains is threatened. Rising interest rates and uncertainty suggest slower growth ahead. Although a recession is inevitable at some point, the expansion could continue well into 2019 given its current momentum.

A key unknown is whether and when rising interest rates might cause a financial shock, such as a plunge in commercial real estate prices as owners struggle to refinance properties. A possible timing for such a shock would be as the Fed nears its targeted three percent federal funds rate currently projected for late in 2019. It is possible that tax cut–induced business investment, deregulation, and a favorable outcome to trade negotiations could result in structural economic changes leading to a higher sustainable growth pace that extends the expansion well beyond 2019.

The most likely path in the near term lies between these bust and boom possibilities. Economic growth peaks in 2018 followed by a gradual descent trend toward a slower but more sustainable pace. The increasing cost of financing trillion-dollar annual deficits and servicing expanding entitlement obligations for programs such as Social Security and Medicare will increasingly weigh on economic growth prospects.

Although the overall economic growth rate is likely headed lower in 2019, the $19 trillion U.S. economy affords plenty of opportunity for regions and industries to experience widely differing growth rates.