Posted by Jeffrey J. Roach, PhD, Chief Economist
Thursday, October 27, 2022
What a Rebound
After two consecutive quarters of negative growth, the U.S. economy grew at a 2.6% annualized rate in the third quarter, driven by a resilient consumer sector. Real personal spending, roughly 70% of the economy, grew 1.4% annualized, slightly slower than the previous quarter.
Net exports were a large contributor to Q3 growth from a narrowing trade deficit. One big driver behind the lower trade deficit was the massive decline in crude oil prices. Crude prices fell over 26% in Q3 as risks of a global slowdown intensified which cut the cost of oil imports into the U.S. during this period. Looking ahead, the trade deficit will likely widen from here as international economies weaken, restricting U.S. exports amid a very strong U.S. dollar. Therefore, net exports will likely detract from Q4 growth and could further impede growth in 2023.
Consumer spending on services was another contributor to Q3 growth. A strong labor market and a stockpile of savings have supported consumer spending so far this year but we do not know how long this can last. Eventually, consumers will retrench as they draw down savings and tap into credit or pull back on spending.
Not surprising, residential investment subtracted from growth as borrowing costs spiked and housing demand plummeted. Outside of the pandemic, residential investment contracted the most since 2010. As housing normalizes in the coming quarters, this category will continue to be a drag on growth for the next few quarters.
Removing the Noise
Trade and inventories are two volatile categories in Gross Domestic Product (GDP), the general metric used to track the economy. In order to get a better view on the trajectory of growth, investors should pay special attention to the inflation-adjusted “final sales to domestic purchaser,” a line item in the GDP report. This combined category of consumer spending and fixed investment spending was roughly flat relative to the previous quarter, putting the run-rate significantly below pre-COVID averages and illustrating the weakening trend in growth.
Conclusion
The U.S. is not currently in recession, given the strength of the consumer sector. However, excluding the more volatile categories, the trajectory for growth looks weak. Therefore, the Federal Reserve may shift to a 0.50% increase in December after a likely 0.75% increase next week. Consumers will be the linchpin for the likelihood of a soft or hard landing. A deteriorating housing market, nagging inflation, and an aggressive Federal Reserve put the economy on unsure footing for 2023. A silver lining is markets may have priced in much of the near-term recession risks.
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