The U.S. economy followed through on its exceptional 4.2% (annualized) performance in Q2 with an impressive 3.5% pace of growth in Q3, slightly above consensus. Impressive growth in consumer spending was a key factor behind the solid growth tally.
Real personal consumer spending grew 4.0% in the quarter. That showing is even more impressive considering it comes on the heels of a 3.8% pace in Q2. This marks the strongest two-quarter pace for consumption in over three years. Strength was broadly based across goods and services, but spending on clothing and recreational goods and vehicles were particularly impressive, posting double digit gains.
Business investment took a breather in the third quarter, up only 0.8%, after setting a blistering pace in the first half of the year. Spending on structures fell 7.9%, after surging 14.5% and 13.9% in the previous two quarters. Investment on equipment was also soft, up only 0.4%, coming off a string of strong quarters. Spending on intellectual property held up better, rising 7.9%.
A 4% contraction in residential investment was another soft spot in the third quarter. That marks the third consecutive quarter of contraction, as new home construction is facing several headwinds, and activity in the resale market remains subdued.
Government spending ramped up further in the third quarter, as overall government spending (including state and local) rose 3.3%. Fiscal stimulus was also evident in a 3.3% gain in federal government expenditure, concentrated in defense spending (+4.6%). Growth in spending at the state and local level has also been healthy, rising 3.2%.
As expected, exports fell back (-3.5%) from their Q2 surge, with the downturn in foods, feeds and beverages (primarily soybeans). Imports grew an impressive 9.1%, mostly concentrated in motor vehicles and consumer goods. On net, trade subtracted 1.8 percentage points from growth after providing a 1.2% boost in Q2.
Hefty inventory stockpiling more than offset the drag from trade in Q3, boosting growth by 2.0 percentage points. That more than recoups its 1.2 percentage point drag in the previous quarter.
Hurricane Florence made initial landfall on September 14th, causing significant damage most notably in the Carolinas. The BEA stated, however, that it is not possible to estimate the overall impact of Florence on third quarter GDP.
Key Implications
The labor market is strong, consumer confidence is high and the wallets of Americans have been feeling a little fatter since the tax cuts earlier this year. So it isn’t too surprising that consumer spending is healthy, but a 4% pace surpassed our expectations. That said, we expect that the growth surge in Q2-Q3 represents the high water mark for the U.S. economy. Growth is expected to come off the boil over the next year as the fuel from fiscal stimulus is spent, but still grow above the economy’s potential. This should help keep inflation pressures brewing and gradual rate hikes on track.
On the other hand, while we expected business investment to take a breather in Q3, it cooled a bit more than expected, and this is where the risks going forward lie. Tensions on the trade front have already distorted trade data, and dented business confidence domestically and abroad. It is increasingly likely that this could delay investment in affected sectors in the coming quarters. It may be a bit early to call the investment slowdown in the third quarter the new trend, but if investment spending continues to be soft, dampening economic growth, the Fed would likely temper the pace of rate hikes.
So far though, there is certainly enough momentum to warrant another hike in December, bringing the upper end of the target range to 2.5%.
