One Quarter of Growth

Real GDP jumped 2.6% in the third quarter, after contracting in the first half of the year. The gain will likely be the only positive quarter of growth for the entire year. 

A sharp narrowing of the trade deficit accounted for all of those gains. Exports picked up as supply chains continued to uncoil, while imports contracted in response to bloated retail inventories. The surge in the value of the dollar and downdraft in export orders suggest those gains will be short lived. Ordering for the holiday season has been weak.

Consumer spending, which represents the backbone of the economy, slowed to a 1.4% annual rate. That is its weakest pace since the first quarter. Spending on services moderated, while spending on goods continued to contract. The bite of inflation showed up in a rapid drop in savings, which for low-income households has now fallen below the pre-pandemic lows. 

A recent household pulse survey by the Census Bureau revealed that more than 40% of households are now reporting it is somewhat or very difficult to meet usual household expenses. Consumer confidence dropped close to a recession level in October with concerns about inflation and a cooling of the labor market weighing on consumer attitudes ahead of the critical holiday season. 

Residential investment continued to crater at an accelerated pace. Builder backlogs have evaporated with the surge in mortgage rates. Even all-cash buyers have moved to the sidelines. No one wants to catch the falling knife of rising rates, falling prices and softening rents. Builders are now renting unsold inventories to cover their costs. The pandemic-induced housing bubble is rapidly deflating. 

Business investment posted modest gains after essentially flatlining in the second quarter. Those gains largely reflect the catch-up in activity following supply chain disruptions earlier in the year and are expected to dissipate with the cooling of domestic demand we are seeing in response to higher interest rates. Core durable goods orders, which are an indicator of business plans, dropped 0.7% in September, which suggests a contraction in investment as we move into the fourth quarter. 

 Inventories dropped modestly but remain bloated. Retailers have slowed their orders going into the holiday season as they are struggling to drain inventories. 

Government spending moved up after contracting during the first half of the year. Defense spending picked up with the war in Ukraine, while state governments started to spend the cash reserves they built up during the pandemic. Some of those gains were used for tax holidays on food and gas and tax rebates designed to offset inflation. Ironically, those shifts tend to make inflation worse by enabling consumers to spend beyond their means. 

Bottom Line

The third quarter will likely be the strongest and only positive quarter of the year. The third quarter gains are not sustainable in the face of rapid rate hikes and the slowdown in growth abroad. Another 0.75% hike by the Fed is all but guaranteed next week. The European Central Bank raised rates by 0.75% today.