Fourth quarter GDP revised to 2.7%

The second release for Q4 GDP resulted in a modest decrease in reported growth for the quarter but didn’t meaningfully change the narrative concerning the economic environment late last year. GDP expanded at an estimated 2.7% in the fourth quarter, a shade lower than the preliminary report of 2.9%. A moderate downward revision had been expected by economists. However, underlying the headline number was a story that wasn’t as positive as above-trend growth suggests.

Consumer spending — the primary engine for the economy — slowed to a 1.4% annualized pace in the last three months of the year, the second weakest quarter for consumer spending since the economy roared out of recession in mid-2020.

Of particular note, consumer spending on goods contracted for the fourth consecutive quarter, while spending on services grew at a 2.4% clip. Household spending preferences have been gradually shifting toward the service sector, which experienced a delayed recovery as social-distancing measures weighed heavily even as spending on goods surged in the early stages of the recovery. That narrative began to change last spring, and spending growth continued to tilt increasingly toward services and away from goods over the latter half of last year.

Soaring home prices and higher mortgage rates continued to cool the once hot housing sector. Residential investment declined at a nearly 26% annualized rate — the third consecutive double-digit quarterly decline. As a broader gauge of the consumer sector’s contribution, the combination of household consumption and residential housing investment contracted during the quarter — a far-from-rosy picture from the key driver of the economy.

Against a comparatively weak backdrop for consumers, other factors had to provide the lift.

The trade picture improved moderately, adding nearly 0.5% to quarterly growth. Government spending also contributed 0.6%, with positive contributions coming from both federal and state and local governments.

Business inventories were a major contributor, adding nearly 1.5% to top-line growth, accounting for more than half of the quarterly GDP gain. Inventories have been whipsawed over the past few years, challenged by intermittent shortages and broken supply chains. That’s resulted in outsized impact on GDP quarter to quarter, sometimes acting as a headwind, but periodically providing a boost as was the case late last year.

Recent data suggests that the economy may have gathered some momentum since the beginning of the year, fueled by a rebound in the service sector and robust retail sales in January suggest that fears of a near-term recession may have been overblown. January job creation was also surprisingly strong, coming in over 500,000, enough to push the jobless rate down to a five-decade low of 3.4%.

That creates a new challenge for a Fed that raised its short-term policy rate at a rapid clip last year in an attempt to cool the economy and knock down inflation. Various inflation measures have receded moderately, but tight labor market conditions and a potential reacceleration in the economy aren’t going to reassure policymakers that they’ve done enough.

There are growing rumblings that the Fed may need to go even further in ratcheting up interest rates than their December projections indicated. One thing appears certain: the Fed is fully committed to administering whatever monetary medicine is needed to cool the inflation fever still gripping the economy.

Additional rate hikes are expected, and their announcement won’t be a surprise. Given the strength of recent data, it will be more surprising if policymakers don’t go even further than anticipated just a few months ago. That could come in the form of larger rate hikes, moving back to 0.5% moves from more tempered 0.25% increases, by lifting short-term rates even higher than forecast, or by holding them higher for longer. Whatever their chosen path, policymakers are likely to be slow to reverse course and shouldn’t be expected to ride to the rescue at the first sign of trouble.

Plenty of questions remain about the path ahead for Fed policy, but what doesn’t appear to be in doubt is their resolve in bringing inflation back down toward their 2% target, even if the byproduct of the policy moves needed to accomplish that ultimately results in job losses and pushes the economy into recession.

The bottom line? Top-line growth late last year remained solid, but the contribution from consumers stalled. Recent data suggests that near-term recession fears may have been overblown, but the economy isn’t out of the danger zone. A soft landing can’t be ruled out, but the risk of a recession later this year remains elevated.

Media mention:

Our experts were recently quoted on this topic in the following publication:

• Fox Business