Thursday’s Q3 real GDP growth beat already-strong expectations, increasing at a 4.9% annualized rate (against 4.5% consensus estimates). That’s the fastest GDP growth in nearly two years and more than double Q2’s 2.1% pace.
Now, the question is whether GDP can keep growing at a solid pace.
Consumer spending leads the way for Q3 earnings growth
Before jumping ahead, though, let’s examine why Q3 GDP was so strong.
Consistent with the resilient consumer demand we’ve been seeing all year, consumer spending accounted for more than half Q3 GDP growth, adding 2.7 percentage points (chart below) to GDP growth (leftmost bar). The balance of growth was mostly driven by inventory building and government spending.
Two of the more rate-sensitive sectors added little to nothing to growth: residential investment (housing) and business investment.
This isn’t too surprising, with mortgage rates averaging over 7% in Q3, putting home sales on pace for their worst year since at least 2011. And, with corporate borrowing costs rising and manufacturing activity in recession, Q3 wasn’t the best time to invest in new structures or equipment.
Consensus sees drop off in Q4 as the economy faces multiple headwinds
From here, the consensus expects real GDP growth to slow to just 0.3% in Q4 (chart below, first grey bar) and then 0% in Q1.
There are some good reasons for that (as we discussed last month) — the resumption of student loan payments reducing disposable income, the UAW strike estimated to already have cost the economy nearly $8 billion, a potential government shutdown cutting government spending, and higher rates reducing investment and spending.
Q4 headwinds may be overstated
But some of these concerns may be overstated.
- The New York Fed estimates student loan payments will only reduce the average borrower’s spending by $56 per month, equivalent to just 0.1% of aggregate spending. With the average payment in the $200-$300 range, that means most of the payment is funded by savings, limiting the impact on spending.
- The UAW made a tentative deal with Ford, which could act as a template for deals with GM and Stellantis. So, there’s a chance the autoworker strike ends soon, allowing two months for catch-up production to offset the would-be hit to Q4 GDP.
- There’s at least a chance we avoid a government shutdown with the election of Mike Johnson as Speaker of the House, giving the government three weeks to pass a spending bill.
And the first data point for Q4 indicated continued economic resilience, with the preliminary October PMIs beating expectations. The manufacturing PMI increased to 50 (chart below, red line), suggesting the manufacturing sector is on the brink of ending its activity recession, while the services PMI stayed in expansion (green line).
Still, the headwinds from higher rates will likely cause some drag, unless we see a significant drop in rates in the next couple of months. Next week’s Fed rate decision may provide some clarity on the outlook for rates.
If consumer spending holds up, the economy might not slow as much as the consensus expects
Even though the consensus is looking for GDP growth to stall in the next couple quarters, it’s worth taking such forecasts with a (big) grain of salt. After all, back in July, the consensus estimated Q3 GDP growth at 0.6%. They were only off by 4.3 percentage points.
So, with the economy facing some headwinds, GDP growth should slow in Q4, it just might not be by as much as the consensus expects currently. And some slowing in GDP growth may actually be needed since the Fed wants to see a period of “below trend” (sub-2%) before ending its rate hike cycle.
We’ll have to watch how consumer spending holds up, since that’s been a key reason why the economy has defied expectations all year.
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