A resilient American economy grew by 2.9% during the final three months of last year because of a strong increase in demand for services by consumers, fixed business investment and inventory restocking.
Overall gross domestic product for the full year increased by 2.1% on an annualized basis.
Overall gross domestic product for the full year increased by 2.1% on an annualized basis and by 1% compared to the same quarter a year ago, ending a challenging year characterized by elevated inflation and 450 basis points of rate hikes by the Federal Reserve to restore price stability.
Perhaps the question is not if the economy is strong. Rather, the question is the economy’s resilience considering the rate shock imposed by the Federal Reserve.
One gets the sense that the economy is past peak inflation because of supply chain normalization that led to modest disinflation in the goods sector. That moderation is constructive and encouraging.
But the economy is not finished absorbing the body blow caused by the Fed’s supersized rate hikes.
Our preferred metric of growth—final sales to domestic purchases, which exclude inventories and trade—grew by only 0.8% in the fourth quarter, according to data released by the Commerce Department on Thursday. That measure is a much better indicator of the true condition of the economy and is indicative of the risks around a recession later this year.
This strongly implies that the top-line GDP number exaggerates where the economy actually is and is a misleading indicator of where it is going given the lagged impact of the inflation and interest rate shocks.
The economy is not finished absorbing the body blow caused by the Fed’s supersized rate hikes.
For example, the lagged impact on housing and manufacturing employment has yet to show up, but we anticipate job losses in those sectors later this year, underscoring our estimation of a 65% probability of a recession over the next 12 months.
At this point, the difference between an economic slowdown and a recession—that ephemeral soft landing—will be the extent to the which wage growth moderates at an accelerating pace and job openings fall in line with the roughly 7 million trend that prevailed before the pandemic. That job openings figure would stand in contrast to the three-month average of 10.5 million and would produce the immaculate disinflation that a soft landing needs.
Despite the economy’s recent resilience, we do not see such a happy ending to a turbulent era of American economic growth.
The data
The solid growth that defined the second half of the year was driven mostly by resurgent consumer demand, which increased by 2.1%, and by outlays on services, which expanded by 2.6% in the final quarter.
Personal consumption contributed 1.42% to overall growth in the quarter. Demand for goods increased by 1.1% and spending on nondurables increased by 1.5%.
Trade (net exports) contributed 0.56% to growth, while inventories added 1.46% during the final three months of the year. The narrowing of the trade deficit reflected the reopening of much of the global economy despite a soaring U.S. dollar.
That narrowing, however, is illusory and will not be sustained as contracts for American exports reset to higher prices driven by a strong greenback, which will push up the trade deficit this year and put a drag on overall growth.
Gross private investment increased by 1.4%, fixed investment declined by 6.7% and nonresidential investment increased by 0.7% during the fourth quarter.
Outlays on productivity-enhancing intellectual property jumped by 5.3%, spending on equipment declined by 3.7%, spending on structures advanced by 0.4% and residential investment declined by a whopping 26.7%.
Our preferred metric for analyzing growth in the real economy—real final demand excluding inventories and trade—advanced by 0.8%, which, for our money, is the major takeaway inside the data. It points to what we expect to be much slower growth this year.
Real final sales increased by 1.4%, gross domestic purchases increased by 2.3%, while final sales to domestic private purchases increased by a paltry 0.2%.
Government consumption increased by 3.7% during the final three months of the year, federal spending jumped by 6.2%, state and local spending advanced by 2.3%, outlays on national defense increased by 2.4% and non-defense spending soared by 11.2%.
The takeaway
Last year’s 2.1% growth reflects resilient American consumers who drew down their impressive stock of savings and prevented a recession. The 2.9% increase in growth during the final quarter was driven by strong demand for services, a narrowing trade deficit, modest business investment and inventory restocking.
But once one excludes inventory restocking and a temporary narrowing of the trade deficit, growth in the economy arrived at an 0.8% pace and sales to private domestic purchases arrived at a weak 0.2%.
As the economy enterers the new year, the top-line data somewhat exaggerates the true underlying pace of growth in the real economy and underscores our baseline forecast that the economy will fall into a moderate recession by midyear.
