Why is the Economy so Strong?

Forget about the below consensus 2.6% increase in real GDP for the fourth quarter. Looking under the hood we find that final sales to private domestic purchases, which takes out the effects of trade, inventories and government, increased at a very strong 4.6% annual rate. Growth was propelled by a 3.8% increase in consumer spending and an 11.4% increase in equipment spending.This follows two quarters of 3% real growth. Simply put the economy is hot and the bond market looked through the headline number and declined. Moreover inflation as measured by the deflator for personal consumption expenditures increased at 2.8% well above the Fed's target and services inflation ran at a very hot 3.1%.

What accounts for this strength after years of so-so 2%  growth? In my opinion it represents a combination of the lagged effects of the extraordinarily easy monetary policies of the past decade, a rebound in the global economy, the deregulation policies of the Trump Administration and the prospect of major tax cuts that were enacted at the end of the quarter. It is not only the deregulation policies, but also businesses no longer live in fear that new regulations will not come from out of the blue as was the case under the Obama Administration. Thus of a sudden capital spending is exploding witnessed by the very strong gain in equipment spending.

Further we appear to be in a self reinforcing cycle of rising stock prices working to push up both consumer and business spending. Nevertheless the party won't go on for too long as the economy is running out of labor in an environment of low productivity growth and that will further increase inflation and lead to more Fed tightening that the market now expects.