US Weekly Economic Commentary: Don’t be fooled by Q4 GDP

According to the first official "advance" estimate from the Bureau of Economic Analysis, US GDP grew at a 2.9% annual rate in the fourth quarter. The headline number was higher than expected and would seem to imply that the economy retained solid momentum through the fourth quarter of 2022.

However, examination of the details, both in the composition of GDP and in the monthly profiles of key indicators, reveals that underlying demand growth is weak, supporting our expectation that GDP growth will turn negative in early 2023 as the economy rolls over into a mild recession.

Fourth-quarter GDP growth was boosted by an outsized increase in inventory investment that accounted for one-half of overall GDP growth (1.5 percentage points) and which was far larger than expected. The increase is likely to have been largely unintended and arose in response to a weakening in final sales, especially private final sales to domestic purchasers, which rose at just a 0.2% annual rate.

Large increases in net exports and government spending accounted for much of the rest of the increase in GDP in the fourth quarter. Growth in government spending is likely to moderate in coming quarters, inventory-building is likely to slow, and net exports are unlikely to post large increases — three reasons why we expect a much weaker GDP profile in the first half of 2023.

Signs of weakness

In addition to issues of composition, monthly profiles on production and spending also suggest that growth weakened significantly late in the quarter. Real personal consumption expenditures (PCE) rose at a respectable 2.5% annual rate in the fourth quarter, but the quarterly figure obscures monthly declines in both November and December at an average annualized rate of 2.9%.

Against the backdrop of sluggish growth in disposable income and high interest rates that suppress spending on consumer durables, we expect PCE to decline 0.2% in the first quarter, a pronounced slowdown from the fourth quarter. Data on orders and shipments point to weakness in business equipment investment, while real construction spending is contracting in both nonresidential and especially residential components. Manufacturing production fell sharply over November and December.

We remain comfortable with a forecast that GDP growth will turn negative in the first quarter, when we project that it will decline at a 1.6% annual rate. This will mark the beginning of what we expect will be a mild recession, to be followed by a slow recovery in the second half of 2023.

Fed downshifts

The Federal Open Market Committee is prepared to hike the target for the federal funds rate by 25 basis points to a range of 4½% to 4¾% at the policy meeting that concludes Feb. 1. This would mark a further downshift in the size of rate adjustments following increases of 75 basis points at four meetings from June through November and an increase of 50 basis points on 14 December.

We will listen closely to the Chair's remarks during the press conference on Feb. 1 for clues about how policymakers have updated their views on the appropriate peak level of interest rates following recent data showing some moderation of inflation and weakness in PCE and other components of private final domestic demand in late 2022.

We expect another quarter-point rate hike in March, after which we expect the FOMC to keep the target range steady until it begins to ease rates in early 2024.

This week's economic releases:

• Conference Board's Consumer Confidence Index (Jan. 31): We estimate an increase to 109.1 in January from 108.3 in December as lower inflation provides some relief to consumers.
• Construction spending (Feb. 1): We estimate a decline of 0.6% in December, compared with an increase of 0.2% in November. Construction prices continue to climb higher at a rapid pace.
• Manufacturers' shipments, inventories and orders (Feb. 2): We estimate inventories rose 0.4% in December after being unchanged in November. Orders for durable goods were already reported to have increased 5.6%.
• Light vehicle sales (Feb. 2): We estimate 15.5 million units sold in January, up from 13.4 million in December. This would be above the average selling pace during the fourth quarter of last year (14.3 million units), an increase that would reflect improving inventories at retail dealerships. A recovering automotive sector is expected to cushion an otherwise weakening economy during the first half of this year.
• Nonfarm payroll employment (Feb. 3): We have seen a broad deceleration in payroll employment for a little over a year.
• Employment cost index (Jan. 31): Tight labor markets are boosting wage growth, but real wages are still declining.
• Productivity and costs (Feb. 2): For the fourth quarter of 2022, we estimate compensation per hour advanced at a 4.2% annual rate and output per hour rose at a 3.3% annual rate. We also estimate unit labor costs increased at a 0.8% annual rate in the fourth quarter, compared to a 2.4% annual rate in the third quarter. Decelerating unit labor costs will ease pressures on prices emanating from labor costs.

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.