Inventory surge boosts fourth-quarter GDP
Decent headline gross domestic product growth belies weakness in several core components.
The devil is in the details of the fourth-quarter U.S. gross domestic product (GDP) report. The Bureau of Economic Analysis on Friday said it rose an annualized 2.9%. While lower than the third quarter’s 3.2% growth, it exceeded both the Bloomberg and Blue Chip consensus estimates of 2.6% and 1.7%, respectively. The Atlanta Fed recently reduced its “GDPNow” model from a 4.1% increase to a 3.5% gain, and our estimate here at Federated Hermes was for an increase of 2.3%.
But the fourth-quarter mix of components tells the real story. Inventory restocking more than tripled from the third quarter (an unsustainable level), imports declined sharply, and government spending surged, collectively accounting for virtually all of the fourth quarter’s GDP growth. On the negative side of the ledger, important categories such as spending on personal consumption and corporate investments disappointed, and housing declined for the seventh consecutive quarter.
Private domestic final sales slowing This metric is perhaps the best indicator of the economy’s underlying fundamental strength because it excludes volatile net trade, inventory liquidation/restocking and government spending. It rose only 0.2% in the fourth quarter, its weakest pace since the second quarter of 2020, when the U.S. economy was mired in its deepest recession ever. It increased 1.1% in the third quarter of 2022 and rose a healthy 2.6% in the fourth quarter of 2021.
Yield curve inversion That trajectory suggests the economy is on a glide path into recession. The difference (spread) between 2- and 10-year Treasury yields been negative for the past year—a reliable indicator of an approaching economic downturn. As the 2-year yield now sits at 4.20% and the 10-year is yielding only 3.50%, the resulting 70 basis-point inversion suggests growing recession risk in coming months.
Inflation continues to recede The core Personal Consumption Expenditure (PCE) index, the Federal Reserve’s preferred measure of inflation, slowed to a growth rate of 4.4% year-over-year (y/y) in December, down from 4.7% in November and from its February 2022 peak of 5.4% (a 39-year high). That’s consistent with improvements we’ve seen in both retail (CPI) and wholesale (PPI) inflation over the past several months.
Will the Fed downshift again? Journalist Nick Timiraos, The Wall Street Journal’s “Fed Whisperer,” recently suggested the Fed may issue a quarter-point hike at its Wednesday meeting, down from the half-point hike in mid-December. If the Fed does opt for a smaller hike, we still expect a total of 75 basis points over the next few months as policymakers are adamant that inflation return to 2%. That suggests another pair of quarter-point rate hikes on March 22 and May 3 and a peak target range of 5-5.25%, at which point we expect it to pause for the balance of 2023. We do not expect the first rate cut until 2024.
Details on the fourth-quarter GDP report:
Personal consumption (70% of GDP) rose a weaker-than-expected 2.1% (accounting for 1.42 percentage points of the gain in overall GDP), versus consensus expectations of a 2.9% increase. This compares with a 2.3% third-quarter gain. Spending on services grew 2.6% in the fourth quarter (versus a 1.1% increase in goods spending), as post-pandemic “revenge travel” continues.
Christmas spending seems to not have gone particularly well, however. It rose 6.3% y/y in October through December versus an outsized 16.6% gain last year. We consider January as a part of holiday shopping as it incorporates returns and many gift card redemptions. Interestingly, the personal savings rate has increased over the past three months, from a 17-year low of 2.4% in September to 3.4% in December. That suggests that consumers were holding dry powder at the expense of holiday spending, with perhaps a fearful eye towards an impending recession.
Inventories rose for the fifth consecutive quarter, surging $129.9 billion in the fourth quarter on a chained-dollar basis. With its addition of 1.46 percentage points, it accounts for roughly half of the full quarter’s growth and is more than triple the third quarter’s $38.7 billion increase. It is unlikely this torrid pace of inventory restocking is sustainable in a slowing economy,
Housing plunged 26.7% (which reduced growth by 1.29 points), marking its seventh consecutive quarter of declines. The third and second quarters fell 27.1% and 17.8%, respectively. Last year, home sales decreased by the most since 2008, as mortgage rates more than doubled from 3% to 7.35% in 2022, new and existing home prices spiked to record highs and affordability plummeted to its worst level since 1986.
Net trade added 0.56 percentage points to GDP. Despite the relative fourth-quarter weakness in the dollar against the yen, pound and euro (rendering our exports cheaper), exports declined 1.3% in the fourth quarter, subtractig 0.15 points, versus strong gains of 14.6% in the third quarter and 13.8% in the second quarter. Imports fell 4.6% in the fourth quarter (the second consecutive quarter of decline after eight consecutive rising quarters), contributing 0.71 points, compared with a 7.3% third-quarter decline.
Corporate nonresidential capital spending rose a modest 0.7% (adding 0.09 points), versus a stronger 6.2% third-quarter gain. After six consecutive quarterly declines, structures rose 0.4% (adding 1 basis point to GDP growth), compared with a 3.6% decline in the third quarter. Equipment spending declined 3.7% in the fourth quarter (subtracting 20 basis points), the largest decline since the second quarter of 2020, versus a strong 10.6% third-quarter gain. Intellectual property spending grew for the eighth consecutive quarter at 5.3% (adding 28 basis points), compared with 6.8% growth in the third quarter.
Government spending rose 3.7%, the same pace as the third and the largest since the first quarter of 2021. This contributed 0.64 points and snapped five consecutive negative quarters. Federal spending rose 6.2% in the fourth quarter (adding 0.39 points), paced by a huge 11.2% increase in nondefense spending (adding 30 basis points). State and local spending rose 2.3% in the fourth quarter (adding 25 basis points) versus a 3.7% third-quarter gain.