The Index of Small Business Optimism fell 2.3 points to 103.0 in September, a significant decline from August. Three of the 10 Index components posted a gain, six declined and one was unchanged. Two of our largest states, Florida and Texas, were devastated by hurricanes in the survey period; however, the response rate in those states was unchanged from prior months. The mail got through, but for large parts of the two states, “shopping” was not possible. Tens of thousands of houses were probably lost and a half million cars rendered inoperable. Hurricane recovery spending will provide a significant boost to economic activity in the fourth quarter and into 2018, reducing the odds of a recession next year. The news about tax reform came out too late to have a significant impact on expectations, the October survey will reflect whatever impact that debate will have.

Second quarter GDP growth was revised upward to 3.1 percent, the best growth rate in years. Third quarter growth will be hampered by the hurricanes in our 2nd and 4th largest states. Shopping was difficult without a boat and if your boat made it to your workplace, it may have been flooded or without power. Rebuilding will add to growth in the fourth quarter, but replacing assets that were lost is not an optimal use of funds, even if necessary. It only replaces wealth lost rather than adding new productive assets to our economy. Third quarter estimates of growth from the Atlanta and New York Federal Reserve Banks range from 2.7 percent to 1.5 percent respectively. Another 3 percent growth quarter is not likely for Q3. However, Q4 is shaping up to be better, even before hurricane recovery stimulus.

The Federal Reserve announced the plan to reduce its $4.5 trillion portfolio. Other things equal, the withdrawal of Federal Reserve demand for Treasury bonds to replace those coming due will put an upward pressure on interest rates. However, other factors such as foreign demand for U.S. securities could easily overwhelm this in the early stages of portfolio reductions. The Federal Reserve will raise its benchmark rate in December in an attempt to produce a federal funds rate that is more “normal” and further away from the “zero floor,” just in case the economy falters and the Fed needs to cut rates.

Owner optimism posted a decline but remained historically very high, driven primarily by reduced optimism about sales, business conditions and the environment for expanding a business. However, fundamental Index components were stronger, with gains in hiring plans and inventory investment plans. Capital spending plans were weaker but down from a very high level last month, returning to levels more typical this year. With recent improvement in other economic indicators including the September ISM Non-Manufacturing Index which is at its highest since 2005, and the prospect of recovery spending, the fourth quarter doesn’t look bad at all.