GDP: Overstated by Inventories, Final Sales Steady

Once again, real GDP headlines misrepresent the pace of growth. GDP rose 2.8 percent in Q3, but underlying demand was 2.0 percent with consumer spending and housing pluses. Inflation came in high at 1.9 percent.

Real Final Sales Up on Consumer and Residential Investment

Headline GDP grew at a 2.8 annualized pace, but was overstated by inventories which contributed 0.84 percentage points. Real final sales, a better measure of underlying demand, grew 2.0 percent in the third quarter after a gain of 2.1 percent in the second quarter (top graph). Year-over-year final sales are up 1.6 percent and we reemphasize the point that final sales provide a good benchmark for the underlying strength of the U.S. economy.

Consumer spending was increased at a 1.5 percent annualized rate in the third quarter and is up 1.8 percent year over year. Durable goods, including autos, have been strong and the slower pace of consumer spending was due to weakness in housing and utilities services. Business investment was mixed in the third quarter with a large gain in structures, but a drop in equipment spending. There were declines in information processing and transportations equipment spending in the third quarter. Our outlook remains for subpar growth in the current expansion compared to the past and the expectations of many analysts.

Housing and Government Spending: Two Positive Stories

Residential investment (middle graph) registered a fifth straight doubledigit gain and we expect that momentum to remain in place. Housing has improved for both single and multifamily components and we believe that these gains will support continued economic growth in the year ahead despite the modest rise in mortgage rates.

Government spending revealed a continued decline in federal spending, both defense and nondefense. However, the real issue for the federal deficits and debt is the mandatory entitlement spending which is not reflected in the GDP numbers. In addition, there is the issue of debt finance, which will become more expensive as intermediate and long-term interest rates rise in the years ahead. State and local spending was up for the second straight quarter and reflects the general improvement in state tax receipts. We expect this improvement to continue.

Inflation: Still Quiescent–Green Light for the Fed

Domestic GDP inflation came in at a 1.8 percent annualized rate in the third quarter and just 1.2 percent year over year (bottom graph) while the PCE deflator, one of the Fed’s inflation benchmarks, held steady at a modest 1.1 percent year over year. Stability has been the lesson for inflation watchers in recent quarters and certainly represents no threat to the current path of easy Fed policy.

Within personal consumption, there was another drop in the prices for durable goods. In contrast, prices have risen above average for structures and residential investment. Overall, the price gauges do not suggest any moves by the Fed or market interest rates.

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