Q3 GDP Report: US Economy Grows Faster Than Expected

Ivanna Hampton: The resilient U.S. economy in the third quarter blew past expectations. The gross domestic product, or GDP, grew faster than expected. Consumer spending powered forward despite tighter financial conditions. What does the data mean for the upcoming quarters? Morningstar Research Services senior U.S. economist Preston Caldwell is joining me to share his outlook. Thanks for being here, Preston.

Preston Caldwell: Thanks for having me, Ivanna.

Hampton: So the third quarter’s growth surged higher than the second quarter. What drove the increase last quarter?

Caldwell: Yeah, so U.S. real GDP grew by 4.9% annualized in the third quarter compared to 2.1% in the second quarter. So that’s a 2.8-percentage-point acceleration. The bulk of that increase was driven by consumption growth, which accelerated to 4% in the third quarter in annualized terms compared to 0.8% in the second quarter. And we also had a large contribution from inventory accumulation, which added alone 1.3 percentage points of the acceleration in GDP growth. So one thing to keep in mind is that inventories, for one, are very volatile. They go up one quarter and then down the next. And so it’s virtually certain that we’re not going to continue to have a 1.3% contribution from inventories for the next several quarters. And also consumption growth can be quite volatile as well, especially over the last year or so. Last year we saw a weak holiday season, which depressed the consumption growth rate in the fourth quarter of last year. So it’s very possible we’ll see that again this year.

Hampton: Now GDP growth of 4.9% was the fastest since 2021. Does this mean the economy’s growth rate has accelerated?

Caldwell: So when we try to gauge the underlying trend in the economy’s growth rate, we don’t want to pay too much attention to the quarter-over-quarter number. For one, these numbers are quoted in annualized terms. So I’m going to get into something a bit wonky here, but it’s important if you read these reports, so bear with me.

So, when we annualized these GDP growth numbers, we’re effectively approximately multiplying them by four. So what really happened was GDP grew by 0.5% in quarter-over-quarter terms in the second quarter of this year, and that bumped up to 1.2% in the third quarter. We approximately multiply that by four, and that’s how you get the 4.9% annualized growth rate that’s quoted in the media. So, the point being is that these fluctuations are not quite as large as the annualized numbers would give you if you don’t understand what that number means. And so we look a lot in order to smooth things out at a year-over-year growth rate. And so that year-over-year growth rate in real GDP was 2.9% in the third quarter, which was an acceleration from the 2.4% in the prior quarter as well as the 1.9% for full year 2022, but not as dramatic as the 4.9% number would suggest.

Hampton: Well, Preston, what do you expect for the U.S. economy in the fourth quarter and in 2024?

Caldwell: We’re expecting, actually, GDP growth to come back to normal in the fourth quarter and then continue to slow after that, eventually getting below 1% on a quarter-over-quarter annualized basis in the middle quarters of 2024. And that’s because, for one, the effects of the Fed’s rate hikes, the largest rate hikes in 40 years, have yet to fully play out. For example, bank credit is still in the process of contracting and that will slow spending in terms of business investment and parts of consumer spending and other areas. And there’s plenty of what we might call “known unknowns” in terms of the potential effects of rate hikes, that we know are out there, but we don’t know exactly where they are. We just know something’s going to pop up in terms of vulnerabilities in the economy. And also I think households will get more conservative in their spending as excess savings deplete, which will weigh on consumption growth over the next year or so.

Hampton: Now, how does this data fit into your thinking about the outlook for the Fed’s policy?

Caldwell: I don’t think the Fed is going to react too greatly to today’s news. They’re going to put it in the kind of context in which I’ve just delivered, which is to say the underlying trend in growth may be accelerating a bit, but not dramatically. But what’s more important for the Fed is that core inflation is coming down. Core inflation as measured by the PCE inflation rate, which was issued today, was 2.4% in quarter-over-quarter annualized terms in the third quarter. So that’s almost back to the Fed’s 2% target. So if that holds up, then the Fed’s job of combating inflation is just about wrapped up. And in fact, if the battle against inflation is won and GDP growth weakens as I expect next year, then the Fed will respond to that by starting to cut interest rates aggressively, which is what I expect.

Hampton: And we’ll hear from the Fed next week. Thank you, Preston, for your time today.

Caldwell: Thanks, Ivanna.