The U.S. economy grew at a modest 2.0% annualized pace in the third quarter, slightly below consensus expectations.
After roaring ahead at a double-digit pace in the first half of the year, consumer spending grew only 1.6% annualized. That masks a massive divergence between spending on goods and services. Spending on durable goods reversed sharply, down 26.2% in Q3, while services grew at a healthy 7.9% pace. That still marks a slowing from 11.5% in the second quarter; some of it a natural deceleration after the initial reopening bounce, but some of it due to the surge in COVID-19 cases.
A reversal in equipment spending (-3.2%) contributed to a modest 1.8% pace for business investment. Structures investment also continued to decline, down 7.3%. Spending on intellectual property products did all the heavy lifting, up 12.2% in Q3, following through on a healthy 12.5% in Q2 and a 15.6% gain in Q1.
Residential investment fell for the second consecutive quarter, down 7.7%. Like spending on consumer durables and business equipment, residential investment grew at an unsustainable pace earlier in the pandemic and remains 13.4% higher than pre-pandemic levels.
Government spending rose a modest 0.8% in Q3, after a decline in Q2. A decline in federal government activity (-4.7%) due to the winddown of the Paycheck Protection Program was more than offset by a jump up in spending at the state and local level (+4.4%) propelled by school re-openings.
Inventories contributed two percentage points to annualized Q3 growth, after drawdowns subtracted an average of two percentage points in the first half of the year.
Imports grew at a healthy 6.1% pace, while exports dropped 2.5% in Q3. Therefore, net exports continued to subtract from growth (-1.1%-pts) as they have every quarter since the rebound began.
Finally, price pressures were strong in Q3, but not quite as strong as Q2. The core PCE deflator rose 4.5% on an annualized quarter-over-quarter basis (versus 6.1% in Q2).
Key Implications
The third quarter’s slowdown can largely be chalked up to the slowdown in consumer spending from a stimulus-driven surge in the first half of the year. Two sizeable rounds of fiscal stimulus drove a surge in durables spending, which, even after Q3’s decline, is still nearly 20% above pre-pandemic levels in real terms. The reversal in durables spending alone subtracted 2.7 percentage points from GDP growth. Supply chain constraints also played a role, with 2.4 percentage points of the durables drop due to the decline in spending on motor vehicles thanks to shortages in autos on dealer lots.
The surge in infections due to the Delta variant played a lesser role for consumers, with some evidence it constrained spending on food services and accommodation. We will see more on that in tomorrow’s monthly PCE data. Delta is perhaps playing a bigger role on the global stage by contributing to shortages of various imported goods, and a slower recovery in many U.S. trading partners, constraining exports. The level of exports remains 10.3% below its Q4 2019 level, one of the only major GDP components, along with non-residential structures investment, that is still below its pre-pandemic level.
The slowdown in economic growth in Q3 is likely to prove a one-off with the economy set to accelerate a 4%+ pace in Q4. Tomorrow’s consumer spending report for September will set the tone on how strong momentum was heading into the fourth quarter. We expect healthy growth in the quarters ahead, but slower than the initial phases of the rebound, as various supply constraints weigh on activity.
