Fourth quarter GDP disappoints
Revisions are possible due to inventory and trade data.
Bottom line
Gross Domestic Product (GDP) grew a weaker-than-expected 2.3% quarter-over-quarter (q/q) annualized pace in the fourth quarter, down from the third quarter’s 3.1% growth. Federated Hermes’ estimate was for 2.5% growth, with the Bloomberg consensus at 2.6% and the Blue-Chip consensus at 2.3% (within a very wide range of 1.8% to 2.6%). The Atlanta Fed gutted its GDPNow estimate of 3.2% on Tuesday of this week to 2.3% on Wednesday, when the advanced goods trade balance for December plunged to a record decline of $122.1 billion, the worst reading in its 36-year history.
What happened? Thanks to stronger-than-expected Christmas spending, personal consumption was substantial, rising 4.2% q/q in the fourth quarter (consensus growth at 3.2%), which added 2.82 percentage points to the overall fourth quarter GDP print, compared with 3.7% third-quarter growth. In fact, that was the strongest quarter for personal consumption since the first quarter of 2023 (up 4.9%). Housing rose for the first time in three quarters, increasing 5.3% q/q and adding 0.21 percentage points to GDP. Government spending rose 2.5% q/q, adding 0.42 points, split evenly between federal and state & local spending.
On the negative side of the ledger, corporate spending declined 2.2% q/q, reducing GDP by 0.31 points and marking the metric’s first decline since the third quarter of 2021, largely due to a sharp drop in equipment spending.
Where are the imports? With the dollar and the US economy robust in general, and certainly compared with our major trading partners, exports declined for the first time in 18 months, down 0.8% q/q. That drop trimmed GDP by 0.08 points. Imports also fell by the same rate, adding 0.12 points. This is surprising to us, given the significant decline in the advanced goods trade balance over the past two months, as US businesses—fearing President Trump might impose higher tariffs on foreign goods—began to accelerate importing ahead of potential price increases. It is possible, we think, that the GDP figures will be revised in coming months.
What about inventory rebuilding? Inventory accumulation grew by a paltry $4.4 billion q/q in the fourth quarter, down from $57.9 billion in the third, subtracting 0.93 percentage points from GDP. This makes little sense to us, as well. However, if imports are revised higher, then inventory accumulation will likely be as well, boosting the economy’s growth.
Private domestic final sales are solid This metric gauges the economy’s underlying fundamental strength, as it excludes volatile inventory liquidation or restocking, net trade and government spending. It rose 3.2% q/q in the fourth quarter, down slightly from a 3.4% increase in the third but up from a 2.7% gain in the second. This suggests that fourth quarter growth was stronger than the headline GDP flash suggests, due to the strongest personal consumption in nearly two years.
Inflation sticky The core Personal Consumption Expenditure (PCE) index (which strips out volatile food and energy prices and is the Federal Reserve’s preferred measure of inflation) rose 2.8% year-over-year (y/y) in December, unchanged over the past three months. While this key metric has certainly declined from its February 2022 peak of 5.6%, it bottomed at 2.6% in June 2024 and has modestly re-accelerated over the past six months.
Wait-and-see approach While core PCE was in line with the Fed’s year-end forecast in its latest Summary of Economic Projections (SEP) in mid-December, policymakers also think it might not decline to its long-run target of 2.0% until the end of 2027—a year later than their earlier forecasts. Consequently, they opted to keep interest rates unchanged at their policy-setting meeting on Wednesday, suggesting a patient, data-dependent approach to future rate adjustments. We are projecting two quarter-point rate cuts later this year, perhaps in June and again in September or December.
Details of the fourth-quarter GDP report:
- Personal consumption (which accounts for 69% of GDP) rose by a much stronger-than-expected 4.2% q/q in the fourth quarter (contributing 2.82 percentage points to the gain in overall GDP), higher than the expected consensus increase of 3.2%. That compares with a 3.7% gain in the third quarter and represents the strongest quarterly gain in nearly two years. Holiday shopping ran above industry forecasts, driven positively by high-end consumption, which offset weaker low-end demand. The National Retail Federation was projecting Christmas sales growth of 2.5-3.5%. But retail sales from October through December have risen a stronger-than-expected 3.8% y/y, versus 2.7% in 2023, the weakest pace in five years.
- Residential construction rose for the first time in three quarters, increasing by 5.3% q/q in the fourth quarter, adding 0.21 points to growth. Housing declined 4.3% and 2.8%, respectively, in the third and second quarters. But that boost may not be sustainable. Mortgage rates have more than doubled to 7% over the past three years, new and existing home prices have spiked 60% to record highs and housing affordability has plummeted to its worst level since the mid-1980s on negative real wage gains. Existing homeowners are reluctant to surrender their low mortgage rates, so inventory levels are low.
- Government spending rose for the tenth consecutive quarter (after five consecutive negative quarters) by 2.5% q/q in the fourth quarter, down from a strong 5.1% increase in the third quarter. Federal spending rose 3.2% q/q in the fourth quarter, which added 0.21 points. State and local spending rose 2.0% in the fourth, adding 0.22 points.
- Corporate nonresidential capital spending declined for the first time in more than three years, falling 2.2% in the fourth quarter, subtracting 0.31 points, versus a gain of 4.0% in the third. Structures were negative for the second consecutive quarter, declining 1.1% in the fourth quarter, compared with a third-quarter decline of 5.0%. But equipment spending was the biggest drag, declining for the first time in five quarters by 7.8% in the fourth quarter (subtracting 0.42), after surging 10.8% in the third. Intellectual property grew a steady 2.6% in the fourth quarter for the 16th-consecutive quarter, compared with a gain of 3.1% in the third.
- Net trade declined by $1.067 trillion in the fourth quarter, which added a modest 0.04 points to growth. Due to the relative fourth-quarter strength in the dollar against the yen, pound and euro (which make our exports more expensive and less attractive) and the relative strength of the US economy (which fuels our ability to purchase foreign goods), exports declined 0.8% q/q in the fourth quarter (subtracting 0.08), compared with robust growth of 9.6% in the third. But imports also declined by 0.8% q/q in the fourth quarter (adding 0.12), compared with a powerful gain of 10.7% in the third. This is suspect, as we know that many US companies have accelerated imports in recent months to beat potential price increase from the possible implementation of Trump’s tariffs. So, this data could be revised in coming months.
- Inventories inched up by only $4.4 billion in the fourth quarter, down sharply from $57.9 billion and $71.7 billion in the third and second quarters, respectively. This sharp sequential decline in the pace of inventory re-stocking reduced overall GDP growth by 0.93 points. This shift is also hard to understand given the increase in imports to front run tariff-related price increases that should have boosted inventories more significantly, creating less of a drag on GDP. This data could also be revised in coming months.