US Weekly Economic Commentary: Q3 surprise but recession looms

U.S. GDP rose at a 2.6% annual rate in the third quarter, according to the first official "advance" estimate from the Bureau of Economic Analysis.

The third-quarter increase contrasted with declines in the first and second quarters that averaged ‑1.1%. The third-quarter increase matched our last tracking estimate and was 0.4 percentage point higher than the consensus estimate. However, the economy was softer in the third quarter than suggested by the headline GDP figure, and those details are consistent with our view that a recession looms as soon as the fourth quarter.

In contrast to the solid increase in GDP, final sales to private domestic purchasers rose a scant 0.1% in the third quarter. This is a better indicator of the weak momentum in domestic private aggregate demand. Outside of private domestic final sales, net exports surged in the third quarter, more than accounting for the GDP increase. A large increase in net exports is unlikely in upcoming quarters.

Some elements of third-quarter GDP did suggest a slightly more favorable hand-off heading into the fourth quarter and contributed to an upward revision to our forecast of fourth-quarter GDP. During the third quarter, inventory investment was lower than we expected, suggesting less of a decline in the fourth quarter (and less of a negative contribution to GDP growth). Personal consumption expenditures (PCE) rose at a moderate, 1.4% annual rate in the third quarter, 0.4 percentage point above expectations.

On balance for the week, we revised up our forecast of fourth-quarter GDP growth by 0.4 percentage point, although it is still below zero, at -0.7%.

Mild recession looms

With weak momentum in private final demand amid substantial tightening in financial conditions, odds continue to favor the US falling into a mild recession beginning in the fourth quarter. Housing investment is already in "recession" in response to the Fed-induced tightening of financial conditions, while investment in nonresidential structures continued to decline in the third quarter.

PCE growth has slowed to a below-trend pace as consumers confront high inflation, large declines in equity wealth since last year, and higher borrowing costs. The unwinding of pent-up demand, which boosted PCE growth last year, has mostly run its course (outside of motor vehicles, where sales continue to be constrained by limited supply) and is no longer a major contributor to growth.

Financial markets continue to experience heightened volatility as investors respond to information on growth, inflation, and developments that might influence the outlook for Federal Reserve monetary policy, as well as global developments.

Heading into next week's scheduled policy meeting, the Federal Open Market Committee (FOMC) is poised to hike interest rates by 75 basis points for the fourth consecutive meeting. This could be the last such "super-sized" Fed rate increase: Multiple FOMC participants have stressed a need to plan for slowing rate hikes at future meetings, in part to guard against the risk of over-tightening monetary policy.

This week's economic releases:

• Construction spending (Nov. 1): We estimate nominal construction spending declined 0.2% in September. This would follow declines over the two prior months, even as construction prices continue to rise rapidly — real construction spending has been weakening.
• Light vehicle sales (Nov. 2): We estimate light vehicles sold at a 14.7 million-unit rate in October. This would be an improvement over recent averages and would be consistent with a recent firming trend in dealer inventories.
• Nominal trade deficit (Nov. 3): We estimate the deficit widened to $71.5 billion in September.
• Manufacturers' shipments, inventories, and orders (Nov. 3): We estimate a 0.1% increase in inventories in September.
• Productivity and costs (Nov. 3): We estimate compensation per hour rose at a 4.4% annual rate and that output per hour rose at a 1.2% annual rate in the third quarter, implying unit labor cost growth of 3.2%. Tight labor markets and rapidly firming labor costs are helping to fuel inflation.
• Non-farm payroll employment (Nov. 4). The consensus estimate is for roughly a 200 thousand rise in nonfarm payroll employment and for the unemployment rate to tick up to 3.6% in October.

Posted 31 October 2022 by Akshat Goel, Senior Economist, US Macro and Consumer Economics, S&P Global Market Intelligence and

Ben Herzon, US Economist, Insights and Analysis, S&P Global Market Intelligence and

Ken Matheny, Executive Director, Research Advisory Specialty Solutions, S&P Global Market Intelligence and

Lawrence Nelson, Senior US Economist, S&P Global Market Intelligence

This article was published by S&P Global Market Intelligence and not by S&P Global Ratings, which is a separately managed division of S&P Global.