Solid fourth quarter GDP
Should keep the Fed on the sidelines in March.
Bottom Line
Gross domestic product (GDP) rose by a stronger-than-expected 3.3% annualized rate in the fourth quarter, though that is sequentially lower than the robust 4.9% increase in the third quarter. The Atlanta Federal Reserve’s GDPNow projected 2.4% growth, Bloomberg consensus had an estimate of 2.0% and Blue-Chip consensus forecasted 1.5%. Our estimate here at Federated Hermes was for 1.9% growth.
What happened? The fourth quarter enjoyed strength across the board, with all six major categories contributing positively. Personal consumption—which rose a stronger-than-expected 2.8%—accounted for nearly 60% of the solid performance. Government spending and net trade also were significant positive contributors, and corporate spending added meaningfully. An $82.7 billion increase in inventories and a second-consecutive positive contribution from housing rounded out the picture.
Private domestic final sales softer This metric gauges the economy’s underlying fundamental strength as it excludes volatile inventory liquidation or restocking, net trade and government spending. It rose 2.6%, slower than the third quarter’s 3.0% gain. We continue to believe that materially slower GDP growth over the next three quarters will decelerate into a soft landing, rather than a mild recession.
Inflation grinding lower The core Personal Consumption Expenditure (PCE) index (the Fed’s preferred measure of inflation) declined to a less-than-expected 2.9% year-over-year (y/y) growth rate in December 2023 (consensus at 3.0%) from 3.2% in November, down from its February 2022 peak at 5.6% (a 39-year high). In its latest Summary of Economic Projections (SEP) in mid-December, the Fed did not change its forecast that core PCE will fall to its long-run target of 2.0% by the end of 2026. Is the Fed being too conservative in trying to avoid another policy error because it began to tighten perhaps a year later than necessary in March 2022? Or do policymakers believe getting core inflation back to its 2% target will be extremely difficult, and do not want to make the mistake of declaring “mission accomplished” prematurely?
Six cuts? Really? Apart from this solid fourth-quarter GDP report, the labor market remains healthy. Initial weekly jobless claims for the January survey week fell to a 16-month low of only 189,000, and January is typically one of the two months (July is the other) in which the Labor Department makes a strong upward seasonal adjustment to the establishment report. In addition, if people have jobs, they continue spending, and last week’s December retail sales report was better than expected. Moreover, business and consumer confidence metrics have strengthened significantly over the past few months.
As a result, we believe the consensus view the Fed will cut interest rates six times this year (the first coming in March) is simply too optimistic. Given the gradual decline of persistent core PCE inflation, we think it will remain vigilant and patient, keeping interest rates higher for longer. We expect the central bank to pause rate action until the second half of this year. At that time, it could orchestrate three rate cuts, perhaps in late July, just after the presidential election in November and in mid-December. We suspect the bond market has begun to sniff this out. After benchmark 10-year Treasury yields plunged from 5.00% in mid-October to 3.80% in late December, they have rebounded to 4.18% in recent weeks.
Details of the fourth-quarter GDP report:
Personal consumption (70% of GDP) rose a solid 2.8% quarter-over-quarter (q/q) in the fourth quarter (accounting for 1.91 percentage points of the total GDP gain), better than the expected consensus gain of 2.5%. But that compares with a stronger third-quarter gain 3.1% q/q. Spending was balanced, with services contributing slightly more than goods.
We continue to expect consumer spending to slow in coming quarters. The personal savings rate has risen from a 17-year low of 2.7% in June 2022 to 3.7% in December 2023. Some consumers (particularly at the lower end of the income spectrum) are making a decided effort to reduce spending and amass dry powder. In addition, excess savings have plunged from a peak of $2.2 trillion in September 2021 to $300 billion in December 2023, and credit card delinquencies have doubled to 3.0% over the past two years.
Easter spending increased only 1.7% in March and April 2023, versus 8.6% in 2022, and Back-to-School spending increased 2.8% in 2023 versus 9.7% in 2022. Similarly, the first three months of Christmas 2023 has risen by 3.9%, compared with 7.1% in 2022. We’re expecting January retail sales results (during which time two-thirds of holiday gift cards are redeemed) to moderate from 2022, as the annual Social Security inflation adjustment will only be 3.2% in 2024 versus 8.7% in 2023.
Government spending rose for the sixth consecutive quarter (after five consecutive negative quarters), increasing 3.3% in the fourth quarter (adding 0.56 points to GDP growth, the second-largest contributor behind personal spending), compared with a 5.8% third quarter gain. Federal spending increased 2.5% (adding 0.16 points), but social spending drove this category, with 4.6% growth. State and local spending rose 3.7% (adding 0.40 points).
Inventories rose $82.7 billion in the fourth quarter, slightly higher than the $77.8 billion increase in the third quarter on a chained-dollar basis. That added a modest 0.07 points to overall growth. With the United Auto Workers strike behind us, we expect this inventory build to unwind in coming quarters.
Residential construction increased 1.1% in the fourth quarter (which added 0.04 points), marking the second consecutive positive contribution to GDP after nine consecutive quarters of declines. That compares with a 6.7% third-quarter gain. But mortgage rates nearly tripled from 3% to 8% over the past two years, new and existing home prices spiked 50% during 2021 and 2022 to record highs, and housing affordability has plummeted to its worst level since the mid-1980s. Despite enormous pent-up demand, the housing market is somewhat frozen at present, as existing homeowners are reluctant to surrender their existing low mortgage rates.
Net trade added 0.43 points to overall GDP growth in the fourth quarter, compared with a modest 3 basis-point addition in the third quarter. Due to relative weakness in the dollar against the yen, pound, and euro (which make our exports more attractive), exports rose 6.3% in the fourth quarter (which added 0.68 points) versus an increase of 5.4% in the third quarter. Imports rose a modest 1.9% in the fourth quarter, which subtracted 0.25 points from GDP growth, compared with a stronger 4.2% gain in the third quarter.
Corporate nonresidential capital spending rose 1.9% in the fourth quarter (which added 26 basis points to overall GDP growth), versus a 1.4% increase in the third quarter. Structures rose for the fifth consecutive quarter 3.2% (adding 0.10 points), compared with an 11.2% third-quarter gain. Equipment spending inched up 1.0% in the fourth quarter (adding 0.05 points), versus a 4.4% decline in the third quarter. Intellectual property spending grew 2.1% for the 12th consecutive quarter (adding 0.11 points), compared with a 1.8% third-quarter gain.