GDP Signals Strength and Need for Smaller Rate Cuts

Yesterday, the latest GDP report showed the U.S. economy remains on solid footing. GDP rose 2.8% on an annualized basis in the preliminary Q3 report, on par with last quarter’s rise of 3.0% and maintaining a 2.5% average pace since the start of the year.

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In the details of the report, personal consumption rose more than expected, gaining 3.7% in the preliminary Q3 report, up nearly one percent from the quarter prior.

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Goods consumption rose 6.0%, due an 8.1% gain in durables consumption and a 4.9% increase in nondurables consumption.

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Services consumption, meanwhile, rose 2.6%, virtually unchanged from a 2.7% increase in the second quarter.

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Gross private investment, a gauge of business spending, increased 0.3% following an 8.3% gain in Q2 held down in part by a lesser buildup in inventories.?Inventories rose by $60.2B in Q3, down from the $71.7B gain in Q2 and shaving off 0.2% from the third-quarter report.

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Fixed investment, meanwhile, which excludes inventories, rose 1.3% in the first-round Q3 report following a 2.3% increase the quarter prior.?

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Nonresidential investment – including office buildings and factories – increased 3.3%, due to an 11.1% jump in equipment investment, and a 0.6% gain in intellectual property investment. Structures investment, however, fell 4.0% in the preliminary Q3 report.

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Residential investment, on the other hand, dropped 5.1% in Q3 following a 2.8% decline in Q2.

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On the trade side, exports surged 8.9%, significantly above the 1.0% gain reported in Q2, while imports increased 11.2% in the preliminary Q3 report.

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Finally, government consumption climbed 5.0% in the third quarter, the most in a year. Federal spending increased 9.7%, due to a 14.9% gain in national defense spending and a 3.2% increase in nondefense spending. State and local spending, meanwhile, rose 2.3%.

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In addition, the Core PCE Price Index rose 2.2% in the third quarter, down from the 2.8% gain in the second quarter and the smallest quarterly increase since Q4 2023.

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Bottom Line: The latest rise in GDP further supports the prospect of achieving a soft landing as well as the need for a slow and tempered pace of rate reductions.?With the November FOMC meeting just one week away, the ongoing hotter-than-expected nature of the incoming data has buoyed calls for a lesser 25bp rate cut on November 7th with the market pricing it in at 96%. Going forward, however, any further indications of outright strength amid persistent sticky inflation could result in expectations for an even smaller pace of cuts or a potential pause.?

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In the aftermath of the latest growth report, former Cleveland Fed President Loretta Mester said there’s a case for a series of smaller 25bp rate cuts instead of a larger 50bp move the Fed opted for in September. Speaking to CNBC yesterday, Mester said, “I think there’s a good case for just doing a series of 25s, because it’s very consistent with what the Fed has been saying. Typically they would like to start a change of cycle with 25, which seems appropriate.” She added, “They can always move faster if it turns out that the economy evolves differently than anticipated.”

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Also yesterday, MBA mortgage applications declined 0.1% in the week ending October 25. The 30-year mortgage rate rose from 6.52% to 6.73%, the highest since the end of July.

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Additionally, ADP reported that private-sector employment rose by 233k in October, well above forecasts and the highest since July 2023, bucking calls for marked weakness in Friday’s NFP report.

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Finally, yesterday, pending home sales jumped 7.4% in September, well surpassing the 1.4% gain expected and following a 0.6% gain in August. Over the past 12 months, pending home sales increased 2.2%.

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This morning, personal income rose 0.3% in September, as expected and following a 0.2% increase in August. Consumer spending, meanwhile, increased 0.5% in September, a tenth of a percentage point more than expected and up from the 0.3% rise the month prior. Year-over-year, consumer spending increased 5.3%, matching the annual increase in August, while personal income rose 5.6% in September, a nine-month low.

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Adjusting for inflation, real consumer spending rose 0.4%, a tenth of a percentage point more than expected, and real income also gained 0.1%?in September for the fourth consecutive month. Over the past 12 months, real spending rose 3.1%, up from the 3.0% annual gain in August and the largest annual increase in nine months, and real disposable personal income gained 3.4% in September for the third consecutive month.

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The PCE rose 0.2% in September, as expected and following a 0.1% gain in August. Year-over-year, headline inflation increased 2.1%, also as expected and the smallest annual increase since February 2021.

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Excluding food and energy, the core PCE rose 0.3% in September, also as expected and following a 0.2% increase in August. Over the past 12 months, core inflation increased 2.7% for the third consecutive month, a tenth of a percentage point more than expected.

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The supercore PCE measure – core services excluding shelter – rose 0.3% in September and increased 3.2% on an annual basis, a downtick from the 3.4% gain in August and a two-month low.

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Bottom Line: Inflation continues?to improve and move closer to the Fed's desired 2% level, although some?underlying measures including the core have slowed the pace?of improvement.?As such, while the progress thus far has been welcome and warrants a less firm pace of policy, the Committee should not lose focus as a return to price stability is not yet a forgone conclusion.??

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Also this morning, initial jobless claims unexpectedly fell 12k from 228k to 216k in the week ending October 26, the lowest since May as the temporary impact form the hurricanes appears to already be dissipating. The four-week average, meanwhile, dropped from 239k to 237k. Continuing claims, or the total number of people claiming ongoing unemployment, dropped from 1.89M to 1.86M.

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Additionally this morning, the Employment Cost Index (ECI) rose 0.8% in the third quarter, down from 0.9% in Q2 and the smallest increase since Q2 2021.

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Tomorrow, we will have an updated look at the labor market. According to Bloomberg, despite the limited impact on the claims report, preliminary estimates suggest Hurricanes Helene and Milton could lower payrolls by 150k in October, potentially resulting in the first negative print since 2020. Of course, timing is everything and it remains uncertain how quickly the broader weakness will filter into the numbers. The median consensus, meanwhile, continues to anticipate a 110k rise in tomorrow’s report.

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For the Fed, weather-related weakness can be easily dismissed. However, it does offer the Committee additional cover to continue with a second-round rate cut next week even in the face of stronger-than-expected data elsewhere in the economy and stubbornly sticky inflation. ??

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Also on Friday, in addition to the nonfarm payrolls report, the S&P Global U.S. manufacturing PMI, along with September construction spending and the ISM Manufacturing Index for October.

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In September, manufacturing activity remained at a reading of 47.2 for the second consecutive month, marking the sixth consecutive month in contractionary territory, or a reading below 50. This month, the ISM Manufacturing Index is expected to tick up to a reading of 47.6.

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-Lindsey Piegza, Ph.D., Chief Economist