Q4 GDP shows solid growth despite a weaker consumer

Coming so long after the end of the quarter and following two prior reports, today’s updated estimate of Q4 GDP wasn’t likely to garner much attention. Based on an additional month of data scrubbing, any changes to prior estimates tend to be limited.

From a big-picture perspective, the change was modest, bumping growth down by a tick to 2.6% in Q4 from a previously reported 2.7%. That wasn’t enough to change the prevailing narrative that the economy expanded at a solid clip to close out the year, while decelerating modestly from its peak 3.2% growth pace for the year in Q3. That reacceleration in the latter half of the year helped to calm concerns about imminent recession risk coming off two quarters of negative growth in the first half.

Still, there were signs in the report that all wasn’t well.

Personal consumption expenditures growth slowed to 1.0% for the quarter. Goods consumption slipped for the fourth consecutive quarter, partially offsetting a 1.6% gain in spending on services. That retrenchment undoubtedly reflected the impact of rising prices but also the normalization of spending after the stimulus-fueled buying binge that corresponded with limited mobility during lockdowns in 2020 and 2021. Notably, that marked the slowest quarterly increase in consumption since the recovery began in mid-2020.

The housing market also showed signs of a sharp retrenchment; residential investment declined by about 25%, smacked by the double-whammy of surging home prices and higher mortgage rates last year.

While today’s report provides an additional degree of clarity about the recent past, attention has already turned to more timely indications of the relative state of the economy today. The forecast range varies but has generally improved since the beginning of the year, with growth expected to remain solidly positive. The Atlanta Fed’s GDPNow indicator projects Q1 growth to reach 3.2%, although its estimates can swing significantly and has materially missed the mark at times.

Recent turmoil in the banking sector is sparking a resurgence in concern about an economy that’s feeling the weight of high inflation and a Fed that’s firmly focused on reining it in. On the heels of multiple bank failures and other institutions coming under pressure earlier this month, questions persist about the strength of bank balance sheets and the impact of depositor outflows on their ability and appetite to continue to extend credit. A more pronounced and extended reduction in the flow of credit would be another significant headwind to growth.

For now, it appears that the economy is continuing to grind forward. Jobless claims increased moderately last week to 198,000 from 191,000 in the week prior but remain below 200,000. By virtually any measure, labor market conditions remain tight — too tight for the Fed to be assured that enough has been done to cool the economy.

Given the proverbial long and variable lag in the effects of monetary policy adjustments to be fully apparent, much of the Fed’s tightening over the past year hasn’t yet been fully absorbed by the economy. But the lessons learned from their predecessors in the 1970s and the desire to not prematurely conclude that the current inflation battle has been won are powerful motivators for the Powell Fed to err to the side of doing more than might be needed to quell price pressures. Broadly, policymakers are still committed to the idea that it’s better to beat inflation than to allow it to become more firmly embedded, which would only necessitate an even more powerful response — and a potentially more severe downturn — further down the road.

That means some degree of additional policy tightening, even as the Fed has opened the door to a new facility to provide liquidity to banks that need it to mitigate the risk of further fallout in the sector.

The bottom line? The potential path for the Fed to knock down inflation while keeping the economy aloft was seemingly narrow and challenging before the events of the last few weeks. With cracks in the banking system becoming apparent, the Fed’s job has become even harder. Recession risk remains in focus given the Fed’s historical track record of struggling to tighten policy while easing the economy to a soft landing.