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.
Estimates of quarterly US Q4 GDP growth (QOQ) | ||
Particulars | Advance (First) Estimate | Second Estimate |
Real GDP | 2.9% | 2.7% |
Current Dollar GDP | 6.5% | 6.7% |
PCE Price Index | 3.2% | 3.7% |
PCE Price Index (ex-food, energy) | 3.9% | 4.3% |
Estimates of quarterly US Q4 GDP growth (YOY) | ||
Particulars | Advance (First) Estimate | Second Estimate |
Real GDP | 1.0% | 0.9% |
Current Dollar GDP | 6.1% | 6.2% |
PCE Price Index | 5.5% | 5.7% |
PCE Price Index (ex-food, energy) | 4.7% | 4.8% |
Estimates of Annual US 2022 GDP growth (YOY) | ||
Particulars | Advance (First) Estimate | Second Estimate |
Real GDP | 2.1% | 2.1% |
Current Dollar GDP | 9.2% | 9.2% |
PCE Price Index | 6.2% | 6.3% |
PCE Price Index (ex-food, energy) | 5.0% | 5.0% |
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.
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.
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.
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.
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.
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!
On 23rd February, the US Bureau of Economic Analysis (BEA) released the second estimate of Q4 GDP.