In the US, the GDP typically goes through 3 estimates for each quarter. The first estimate for Q4 GDP had pegged the growth at 2.9% and in the second estimate this has been revised lower by 20 bps to 2.7%. There will be the final estimate coming out around the end of March. This is a slight contrast to the third quarter when the second and third estimate had seen an upgrade to the Q3 GDP first advance estimate. The reason for the lower GDP has been a fall in consumer spending, but we come back to that point later.

What has driven 2.7% growth in US GDP in Q4?

Before getting into the reasons for the lower GDP estimates, let us first get into the key drivers of this 2.7% GDP growth for the fourth quarter as per second estimate. The 2.7% growth in GDP in Q4 was triggered by increases in private inventory investment, consumer spending, non-residential fixed investment as well as federal, state and local government spending. However, this was largely offset by a decrease in residential fixed investment as well as lower exports. Let us get into the granular factors that triggered the shift in each of these pulls and pushes to the GDP number.

For instance, during Q4, the increase in private inventory investment was triggered by manufacturing demand from petroleum and coal sector. Other sectors like mining, utilities, and construction industries also contributed to inventory investment. On the highly sensitive of consumer spending, there was an increase in consumer spending on goods, which was more than offset by a fall in consumer spending on goods. This can be attributed to the higher inflation in services. Healthcare, housing and utility services were among the key drivers of consumer demand in the consumer segment. However, this was offset by a fall in consumer spending on goods like jewellery, new homes etc. 

Like in the first estimate analysis, higher Federal spending was driven by non-defence spending while the thrust came from state and local governments spending the increase in compensation of state and local government employees. Let us also talk about global trade which plays a key part in the decomposition of GDP growth. For the quarter, exports of non-durable goods other than petroleum fell. However, this was offset by higher export of travel and transport services. Imports saw a sharp fall in the imports of durable consumer goods but imports of travel services were sharply higher. Overall, positive news for GDP came from higher private inventory and higher government spending. Negative triggers came from weak consumer demand and a lower fall in imports.

What led to 20 bps lower GDP estimates for Q4?

In the previous para, we have broadly seen the decomposition of the various products and services that exerted the pull and push on GDP. The big question is how do we explain the 20 bps lowering of the second estimate of GDP compared to the first advance estimate. The below table comparing the GDP growth rate on a YOY and QOQ basis would clarify the issue much better. We look at quarterly growth (QOQ and YOY) and annual growth for 2022.

Data Source: US BEA

The table above presents the GDP growth estimates as sequential quarterly growth, yoy quarterly growth and full year 2022 growth. Here are some key takeaways.

1. On a QOQ sequential basis, the real GDP growth has been cut for the fourth quarter by 20 bps from 2.9% to 2.7% as compared to the first advance estimate. This has been largely triggered by lower consumption spending in the US.
   
    
2. This has also been the trend if you look at quarterly GDP on a yoy basis. Even here, the fourth quarter GDP has been downsized by 10 bps from 1.0% to 0.9%. On the other hand, the annual growth rate for 2022 has been maintained constant at 2.1%.
   
    
3. However, during this period, the current dollar GDP or the nominal GDP has actually been upgraded. For instance, the QOQ nominal GDP growth has been upped from 6.5% to 6.7% in the second estimate, while quarterly yoy growth rate has been upped from 6.1% to 6.2%. Annual nominal growth rate remains the same.
   
    
4. The reason for the downgrade in the real GDP, despite the higher nominal GDP for the quarter in the second estimate indicates that inflation expectations have turned higher. That has been the reason for the contrasting moves of nominal and real GDP.
   
    
5. That is evident if we look at the PCE (personal consumption expenditure) driven inflation in the second estimate, which has been raised from 5.2% to 5.7%. PCE inflation is the inflation (not consumer inflation) that Fed uses for its rate outlook.

The second estimate is assuming a sharply higher inflation compared to the first estimate of fourth quarter GDP, which explains the lower real GDP estimate at 2.7%.

Will GDP data change the Fed rates outlook?

One question is whether the lower growth assumption will drive the Fed to go slow on rate hikes since this could be seen as a signal of slowing growth. Already, most economists and policymakers have warned of too much hawkishness having an impact on the GDP growth and even driving the US economy into recession. However, in reality, the Federal Open Markets Committee (FOMC) may treat the latest data flow as an affirmation of their belief that real growth is being pressured by inflation and nothing else. Here is what the Fed could do in coming months.

• If you look at the second estimate of US GDP for the fourth quarter on a QOQ basis and also on yoy basis, the real GDP is falling while the nominal GDP is higher. This gap is best explained by higher inflation, which is evident when we look at the sharply higher PCE inflation assumed in the GDP estimates.
  
   
• The second thing that is evident from the GDP numbers is that consumer spending on goods is visibly slowing down. That is exactly what the Fed wanted and so the Fed is going to take that as an indication that its tightening strategy is working. That will also ensure that there is no let up in the hawkishness of the Fed.

Are there are any takeaways for the Indian economy?

The good news is that despite the hawkishness of the Fed, the nominal GDP growth is still strong. Therefore, the Fed assumption is largely correct that by managing inflation, they will be able to boost real growth. Even the RBI has adopted a similar policy and this only means that the RBI may not give up on hawkishness too soon. For now, the RBI may target a higher terminal rate of above 7% and that is likely to have an impact on cost of funding. But, that would be a separate debate altogether.

For the third quarter ended September 2022 the US GDP growth had been pegged at 2.6% in the first estimate and at 29% in the second estimate. The third and final estimate of Q3 GDP released on 22nd December has pegged Q3-2022 GDP growth at a healthy clip of 3.2% per the latest estimates put out by the US Bureau of Economic Analysis (BEA). This is significant coming after 2 consecutive quarters of GDP contraction. US GDP had contracted by -1.6% in the March 2022 quarter and at the rate of -0.6% yoy in the June quarter. The latest bounce in Q3, not only signals positive momentum, but also demolishes the recession allegations on the US economy.

When the GDP growth of the US economy had contracted in the first two quarters of 2022,it had raised serious questions over whether the aggressive hawkishness of the Fed had resulted in serious damage to the US growth engine. Even at that time, the US had maintained that the negative GDP growth was an outcome of high inflation and not of weak nominal growth. that argument appears to be ratified for now.

Real GDP growth in Q3 by industry groups

The third and final estimate for the third quarter GDP has also included the estimates of GDP by industry, giving a picture of which sectors were having a positive impact on GDP and which sectors were having a negative impact. Out of the 22 industry groups, 16 were in the positive while 6 industry groups were in the negative. Here are some key takeaways from the industry wise classification of US Q3 GDP growth.

1. Private services grew by 4.9% during the quarter while government driven GDP increased by 0.6%. The negative contribution came from the private sector goods manufacturing, which contracted by 1.3% on a yoy basis.
   
    
2. Within the private sector services industry, the biggest contributors to GDP growth were the information segment, professional services, scientific services, technical services, as well as real estate, rental and leasing. In the services space, the contraction was seen in utilities, finance and insurance services. 
   
    
3. The increase in government contribution was led by an increased contribution of state and local governments even as there was a decrease in the contribution of the Federal government. In terms of private sector goods production, the sharp fall was led by construction while that offset partially by an increase in mining.

Back to basics; what were key drivers of US GDP in Q3

What were the major contributors to the +3.2% GDP growth in the third quarter. It must be kept in mind that the first estimate of Q3GDP had pegged the growth at 2.6%, which was later raised to 2.9% in the second estimate and now to 3.2% in the third and final estimate. The graph below captures the drivers of the 3.2% GDP growth in Q3.

A quick view of the chart is that trade and consumer spending continues to be the big drivers of US GDP growth while housing and tepid business investments in inventories were dragging GDP down. Here are some key takeaways.

• Exports had a positive contribution to the real GDP growth in the third quarter. For instance, the increase in exports reflected both goods (led by industrial supplies and materials, non-automotive capital goods and business and travel services.
  
   
• Another related contribution to the GDP growth in the third quarter came from reduced imports. In fact, the fall in imports in the quarter reflected decrease in goods (led by consumer goods) and services (led by transport). It was partially the slowdown effect.
  
   
• The increase in consumer spending was led by services rather than by physical goods. There was an increase in the contribution of healthcare and other services but this enthusiasm was partly offset by a decrease in motor vehicles, food and beverages as well as other miscellaneous goods.
  
   
• How do we interpret the increase in business investment. It broadly reflects the increases in equipment and intellectual property products. However, this was again partially offset by a decrease in structures.
  
   
• The decrease in housing investment was led by a sharp fall in the new single-family housing construction. At the same time, the fall in private inventory investment was led by reduced demand from clothing retail and general merchandise retail. 

Overall, the narrative is the same. Private consumption continues to soar in services but housing and construction activity continue to be hit the most by hawkishness. Demand for consumer goods has also been tepid.

What does the GDP reading tell us about rates trajectory?

The US Fed appears to believe that higher rates is conductive to growth rather than being antithetical to growth. In a sense they are correct, in that the hawkishness has brought down inflation and in the process it has improved the real GDP growth. After hiking the rates by 75 bps on 4 occasions, the Fed tapered its rate hike to 50 bps in December. The Fed rates were already in the range of 3.75% to 4.00% prior to the December policy. With Fed hiking rates by 50 bps in December, the rates are already at the range of 4.25% to 4.50%. 

That is a full 200 bps above the neutral rate, so the lag effect on inflation should continue. Also, in its December meeting, the Fed statement hinted at another 75 bps of rate hikes at the bare minimum, which should take Fed rates to the range of 5.00% to 5.25%. That corresponds with the Fed terminal rate target of 5.1%. In short, notwithstanding the good growth numbers the Fed is not yet done with its rate hikes. There is at least 3 more rate hikes of 25 bps each to come. That is unless the growth situation gets really bad, which case, the Fed may have to shift its narrative rapidly from inflation to growth.

Does the GDP data come as Manna from Heaven

That may be too optimistic, but the positives in the growth data cannot be missed.

• It is not often that you get to see 3 consecutive upgrades of the same quarter growth data. For the third quarter, the GDP data has been upgraded from 2.6% to 2.9% and later to 3.2%. The positive momentum is likely to be growth accretive to the US economy and the spill-over effects should be positive for countries like India.
  
   
• Contrary to what the sceptics may believe, the Fed may have just about managed to secure a soft landing. The good news is that after a full year of hawkishness, the Fed has been able to report positive GDP growth in the third quarter with favourable momentum. For now, it indicates that a hard landing can still be avoided.
  
   
• In India, the RBI has also toned down its hawkishness while refusing to relent on the battle against inflation. Indian economy has shown a lot of resilience amidst the headwinds with the promise of growing at 6.8% for FY23. If that works, India too may have avoided a hard landing.

The Q3 US GDP data with 3 upgrades has surely come as manna from heaven for the US markets as well as the Indian markets. It shows that hawkish policy need not be inconsistent with growth triggers. For now, that is the good news!