US Q3 GDP turns around to positive zone at +2.6%

28 Oct 2022 , 09:54 AM

It is likely to show positive yoy growth of +2.6% and also positive sequential QOQ growth of +0.6%. This comes after 2 consecutive quarters of negative GDP growth in the US. In the March 2022 quarter, US GDP had contracted by -1.6% while in the June 2022 quarter, the US GDP had contracted by -0.6% yoy.

As the graphic above shows, the US economy rebounded in the third quarter ended September 2022 after contracting for the first 6 months of calendar 2022. However, the growth in GDP was largely driven by a narrowing trade deficit which glossed over the fact that the consumption led growth was still missing in the US economy. But, more about that later. For now, it is a certain turnaround in real GDP growth despite high inflation levels.

How narrowing trade deficit boosted US GDP in Q3?

After the real GDP had contracted by -1.6% in Q1 and by -0.6% in Q2, the rebound in the third quarter was much better than envisaged. However, scratch the surface, and the real story is that this bounce in the GDP has been driven by a sharply narrowing trade deficit for the US economy. Even as exports rose despite a strong dollar, the fall in domestic demand reduced the imports and that gave a fillip to the trade deficit position. Normally, 2 quarters of negative growth is classified as recession. However, the Fed and the BEA had maintained the stance that nominal growth in GDP was still strong and negative GDP growth was purely a statistical aberration due to high inflation. It sort of redeems this optimistic argument.

The question is not of whether the US economy is already in recession but whether the US economy will eventually dip into a recession. The inverted yield curve does appear to indicate that a recession in the next one year looks like an eminent possibility. Also, the impact of the series of rate cuts is beginning to show in spending sensitive pockets like retail consumption, household spending and housing demand.

How much higher will the rates go from here?

Perhaps the one point that will answer the recession question is, how much higher would the Fed rates go from here. Fed rates are already in the range of 3.00% to 3.25%. In the last 3 Fed meetings, the FOMC has consistently raised the rates by 75 basis points. If you look at the language of the FOMC members and the indications coming from the CME Fedwatch, there is a 90% probability of another 75 bps rate hike in the 02nd November Fed meet and an additional 50 bps rate hike in the 14th December Fed statement.

That means; by the end of calendar 2022, the Fed rates would have touched the range of 4.25% to 4.50%. That is very close to the planned terminal Fed rate of 4.6%, so this opens up the possibility that the Fed rates may eventually go well beyond the 5% mark. That would be about 250 to 300 bps above the growth-neutral rate and is likely to put a lot of pressure on the GDP growth. That is raising concerns that while the US economy may have avoided a recession for now, it would be tough to eventually prevent an eventual recession. The impact on consumption and spending is visible and once the unemployment rate starts rising towards the 5% mark, the slowdown could will more evident and inevitable.

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

The chart below captures the contributors to the +2.6% GDP growth in the third quarter.

What do we gather from the above table. It shows the positive and negative contributors to the US real GDP growth of 2.6% in the third quarter ended September 2022. Clearly, the bulk of the positive thrust to GDP growth has come from merchandise trade, with exports growing much faster and imports tapering. Consumer spending is positive, but at below 1%, it is disappointing compared to the quarterly median. The big disappointments are from investments in inventory and the negative growth in housing investments. That is a clear indication that the US consumers are still wary of a slowdown in the economy and are going slow on financial commitments.

Here are some key takeaways.

1. Consumption spending saw an increase in the consumption of services like healthcare and other services. However, that was offset by lower demand for goods with demand pressure coming from motor vehicles, food and beverages.
2. The increase in government spending as shown in the above graphic is largely reflective of a spike in defence spending.
3. The fall in housing investments was driven by single family housing units and broker commissions, while private inventory reduction reflected the pressure on retail trade.
4. On the trade front, the positive contribution from imports reflects a fall in imports, which combined with higher exports, has resulted in narrowing the trade deficit.
5. While the real disposable personal incomes (DPI) expanded by 1.7% in Q3, it was reflective of enhanced compensation and personal income receipts from assets. However, savings as a percentage of DPI actually contracted 10 bps to 3.3% in Q3.
6. Finally, the positive takeaway is the good news on the inflation front. The gross domestic purchase prices of goods and services for US residents in Q3 tapered to 4.6% from 8.5% in Q2. If you look at core inflation (excluding food and energy), then the spike in Q3 was 4.8% compared to 6.9% in Q2. While consumer inflation may not report this subtle shift, it is obvious in the PCE (personal consumption expenditure) inflation for Q3 over Q2.

What does this GDP data mean for India?

For the Indian economy and for Indian policy makers, there are several key takeaways from this turnaround reported in the third quarter by the US economy.

• The PCE data points are reflecting the reality that inflation is reacting to persistent hikes in the Fed rate and prices are tapering. This also means that US may be able to bring inflation lower without putting the economy at risk of a hard landing. That would be good news for the Indian economy, which does have a strong US correlation.
• The RBI has already called for a special interim MPC meet a day after the Fed statement. Clearly, the idea is to have a back-up plan post the US action instead of wating till December for its regular MPC meet. This meeting has also been necessitated since the inflation rate has not appreciably come down despite 190 bps of rate hikes by RBI.
• The third quarter data in the US shows that the US economy may have just about managed to reduce inflation without rocking the growth boat. That is good news for the RBI since it could mean that the Fed may not have reasons to go much higher beyond 4.6% terminal rate. That would obviate the immediate risks of capital outflows.

The Q3 US GDP data has brought a ray of hope for the US markets as well as the Indian markets that a hawkish policy can achieve its ends without rocking the growth story. But for a more conclusive and decisive answer, we may have to wait for a few more quarters.