US Economy Recorded Robust Growth In Q4, But With Underlying Weakness

Summary

• Fourth-quarter GDP rises at 2.9% rate
• Consumer spending steady; business investment weakens
• Weekly jobless claims drop 6,000 to 186,000

The US economy expanded faster than expected in the December quarter, but that probably exaggerates the nation’s health as a measure of domestic demand increased at its slowest pace in 2-1/2 years, indicating the impact of higher borrowing costs.

The Commerce Department’s advance fourth-quarter gross domestic product report on Thursday revealed half of the boost to growth stemmed from a sharp surge in inventory held by businesses, some of which is possibly unwanted.

While consumer spending kept a steady pace of growth, a large chunk of the rise in consumption was early in the fourth quarter. Retail sales declined sharply in November and December. Business spending on equipment shrunk last quarter and is likely to remain on the back foot as demand for goods weakens.

It could be the last quarter of steady GDP increase before the delayed effects of the Federal Reserve’s fastest monetary policy tightening cycle since the 1980s are fully felt. Most economists forecast a recession by the back half of the year, though a short and mild one as opposed to previous downturns, due to extraordinary labor market strength.

“The U.S. economy isn’t falling off a cliff, but it is losing stamina and risks contracting early this year,” said Sal Guatieri, a senior economist at BMO Capital Markets in Toronto. “That should limit the Fed to just two more small rate increases in coming months.”

Gross domestic product rose at a 2.9% annualized rate in the fourth quarter. The economy expanded at a 3.2% pace in the third quarter. Economists surveyed by Reuters had expected GDP would increase at a 2.6% rate.

Strong second-half growth wiped out the 1.1% contraction in the first half of last year. For 2022, the economy grew 2.1%, a fall from the 5.9% recorded in 2021. The Fed last year hiked its policy rate by 425 basis points from near zero to a 4.25%-4.50% range, the highest since late 2007.

Consumer spending, which makes up more than two-thirds of U.S. economic activity, rose at a 2.1% rate, mostly indicating a rebound in goods spending at the beginning of the quarter, mainly on motor vehicles. Consumers also spent on services like housing, healthcare, utilities, and personal care.

Spending, which increased at a 2.3 percentage point pace in the third quarter, has been shored up by labor market resilience along with excess savings amassed during the COVID-19 pandemic. Income at the disposal of households after accounting for inflation rose at a 3.3% rate after increasing at a 1.0% pace in the third quarter. The saving rate increased to 2.9% from 2.7%.

But demand for long-lasting manufactured goods, which are largely bought on credit, has ebbed and some households, particularly lower income, have exhausted their savings.

As a result, inventories rose at a $129.9 billion rate in comparison to a $38.7 billion rate in the previous quarter, adding 1.46% to GDP growth. There also were contributions from government spending and a smaller trade deficit.

Stripping out inventories, trade, and government spending, domestic demand rose at only a 0.2% rate. That was the smallest rise in private domestic final sales since the second quarter of 2020 and was a decline from the prior quarter’s 1.1% pace.

“Rising inventories could bode poorly for growth in early 2023 as corporations may look to reduce excess stocks of goods,” said Erik Norland, senior economist at CME Group.

Stocks on Wall Street were trading higher. The dollar surged against a basket of currencies. Prices of U.S. Treasuries plunged.

Rolling Recession

Despite evident signs of a weak handover to 2023, some economists are cautiously bullish that the economy will avoid a complete recession, suffering instead a rolling downturn where sectors decline in turn instead of all at once.

They asserted that monetary policy now acts with a shorter lag than was previously the case owing to advances in technology and the U.S. central bank’s transparency, which they said caused financial markets and the real economy to act in anticipation of rate increases.

Though residential investment faced its seventh consecutive quarterly fall, the longest such streak since the collapse of the housing bubble stoked the 2007-2009 Great Recession, there are signs the housing market could be steadying.

Mortgage rates have been moving downwards as the Fed reduces the pace of its rate increases.

“A large portion of the reaction to higher interest rates is already in the economy and the financial markets,” said Sung Won Sohn, a finance and economics professor at Loyola Marymount University in Los Angeles. “Since the Fed has succeeded in precipitating a rolling recession, it is time to think about an exit strategy.”

Inflation also eased in the December quarter. A measure of inflation in the economy increased at a 3.2% rate, falling from the previous quarter’s 4.8% pace of increase. While many sectors of the economy have switched to lower gear, the labor market is showing no signs of significant cooling.

Another report from the Labor Department on Thursday showed initial claims for state jobless benefits dropped 6,000 to a seasonally adjusted 186,000 for the week ended Jan. 21, the lowest level since April last year. The number of people getting benefits after an initial week of aid, a proxy for hiring, rose 20,000 to 1.675 million for the week ended Jan. 14.

Firms outside the technology industry as well as interest-rate-sensitive sectors like finance and housing are hoarding workers after grappling to find labor during the pandemic.

“There are no signs in the latest jobless claims data that the labor market is cracking at the start of the new year,” said Conrad DeQuadros, senior economic advisor at Brean Capital in New York.