Q2 2023 GDP: Growth Accelerates

Summary

• GDP was higher than consensus, and trend growth accelerated.
• Consumption slowed from the unsustainable Q1 growth, while resilient spending on durables signaled households optimism.
• Non-residential investment recovered, while continued contraction in residential investment is likely to reflect statistical noise rather than genuine weakness.
• Government spending further added to the growth acceleration.

Market Implications

• The market continues to underprice the Federal Reserve (Fed), especially in 2024.

Positive Surprise

As I expected, GDP surprised on the upside, at 2.4% QoQ SAAR vs consensus 1.8% (Table 1). This is above trend of about 2%.

Final sales to domestic purchasers, which exclude the volatile categories of inventories changes and net exports were up 2.3% QoQ SAAR. Final sales growth has been trending up since mid-2022. In addition, final sales growth was close to GDP, suggesting the pandemic-related large inventories cycles could be over. This is yet another sign of normalizing aggregate supply and demand.

Consumption Signals Household Optimism

Consumption slowed to 1.6% QoQ SAAR from 4.2% in Q1, but was higher than consensus expectations of 1.2% (Table 2). The main driver of the slowdown was spending normalization: spending on cars contracted following a 45% increase in Q1. H1 2023 over H2 2022 car spending growth annualized was 19%. Non-durable goods and services spending growth moved closer to the trend of about 2%.

By contrast, spending on recreational goods increased by 10%, following a 6% increase in Q1.  We must wait until today’s monthly data on personal spending to get the details.

The resiliency of durables consumption is striking considering that it remains well above trend (Chart 2). It is likely to signal household optimism, which is consistent with the strong labour market and rising real wages.

Fixed Investment Recovers

Capex (non-residential fixed investment) rebounded after a weak Q1, driven by a swing in transportation and industrial equipment (Table 1). H1 2023/H2 2022 capex growth was 3.1% SAAR.

Q2 capex spending was consistent with the post-pandemic trends of (Chart 3):

• Accelerating spending growth on structures, on the back of the administration’s abundant subsidies.
• Strong software spending, in part to offset availability and cost-of-labour.
• Sluggish spending on computers, that fell relative to GDP, possibly due to over-spending during the pandemic.
• Sluggish recovery in non-computer equipment spending, though the recovery is likely to pick up as the new factories being built will need to be filled with equipment!

Residential investment contracted at the same pace as in Q1, which is inconsistent with the monthly residential construction and housing starts data showing a recovery (Chart 4). It is likely to be revised up in the next GDP releases.

Government Sector Continues Fuelling Demand Growth

Government spending on goods and services (spending on transfers is not included in the national accounts) contributed to Q2 growth (Table 4).

Despite the very strong recovery, non-defence Federal government spending remains nearly half a percentage point of GDP above pre-pandemic levels (Chart 5). By contrast, defense and state and local government spending is below pre-pandemic levels, relative to GDP.

Market Consequences

At the July FOMC, the Fed upgraded its assessment of growth from ‘modest’ to ‘moderate’. Today’s data is consistent with the upgrade, especially as the FOMC estimate of trend growth is 1.8%.

Also during the presser, Chair Jerome Powell stated that, ‘At the margin, stronger growth could lead, over time, to higher inflation and that would require an appropriate response for monetary policy.’

Because Powell sees the policy stance as already deeply restrictive, the policy response is more likely to come from fewer 2024 rate cuts than additional 2023 rate hikes. 

Following the GDP release, the OIS based estimate of the December 2024 Federal Funds Rate (FFR) increased by 14bp to 4.2%, while the Dec 2023 FFR increased by 3bp only. 

Yet, the OIS-based December 2024 FFR remains well below my expectation of 5.6%.

Dominique Dwor-Frecaut is a macro strategist based in Southern California. She has worked on EM and DMs at hedge funds, on the sell side, the NY Fed, the IMF, and the World Bank. She joined Macro Hive soon after its inception.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)