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At first glance, most of the key economic data released this week paints the picture of a strong economy, but as any mechanic will tell you, it is best to look under the hood for the real reason behind the noise. This is true with economic reports as well. The U.S. economy grew 2.9% in the fourth quarter, better than expected, yet slower than the 3.2% pace in the third quarter. The consumption portion of economic growth, which accounts for 75% of Gross Domestic Product (GDP), rose 2.1% during the last three months of 2022, much lower than expected and lower than the prior quarter. Therein lies the concern. The consumer is feeling pinched by the rising cost of living, dwindling savings and concern about job security. Demand for goods has been falling for months. Spending on services drove growth in the fourth quarter, but that is beginning to change. Services spending was flat in December for the first time in a year, while spending on goods fell 0.9%.
The strength in GDP during the fourth quarter came from a double whammy we don’t see very often – positive contributions from both inventory and trade. Trade added 0.6% to growth and was only positive because exports fell less than imports did, even though both categories were negative. Growth from inventory build-up, in this case adding 1.5% to GDP, can be misleading. It represents unsold goods which will likely have to be unloaded at reduced costs in the future. When the effect of trade and inventory is removed, the measure of underlying demand increased 0.8% in the fourth quarter after a 1.5% gain. The consumer impact is fading.
The other story that deserves a second look under the hood is durable goods orders. Orders rose 5.6% in December, more than double expectations and the strongest pace in more than two years. Most of the growth came from a 115.5% surge in Boeing aircraft orders. Core capital goods orders, a proxy for business investment and a more reliable indicator of manufacturing activity, fell 0.2%. It is highly likely that the January durable goods orders will be much lower or even negative.
The one piece of good news in the quarterly GDP report was a significant drop in the price index, falling from 4.7% to 3.9%. This is the slowest pace since the first quarter of 2021. On top of that, the Federal Reserve’s favored inflation gauge, core year-over-year personal consumption expenditure (PCE), showed similar improvement, falling to 4.4%, the lowest level in over a year.
Even though these reports are a look in the rearview mirror, the data provides enough insight to see the current trend in economic activity. Demand is slowing, which will have far-reaching impacts on manufacturing, jobs and corporate growth. Inflation is also coming down. The Federal Reserve’s plan appears to be working and could be leading the U.S. toward a “soft landing,” one in which tighter monetary policy slows household spending, lowers inflation and manages to avoid skyrocketing unemployment levels. The Fed wants an economy running below potential and we are not there yet. In fact, weekly unemployment claims are falling, not rising. Not enough slack has been created to continue bringing down inflation at the pace the Fed would like to see. The question is whether inflation will be able to fall at the same rapid pace we have seen the past few months or if it will stall. The Fed is intent on raising fed funds to a terminal rate above 5% and keeping it there to prevent a relapse. Recent data gives the central bank room to cut back on earlier aggressive moves, leaving the door open for a 25-basis-point increase at the February 1 meeting.
Sarina Freedland – Senior Investment Officer
Although this information has been obtained from sources we believe to be reliable, we do not guarantee its accuracy and it may be incomplete or condensed. This is for informational purposed only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. All herein listed securities are subject to availability and change in price. Past performance is not indicative of future results. Changes in any assumption may have a material effect on projected results.
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