US Real Gross Domestic Product rose by 4.9 percent (annualized) during the third quarter of 2023, above the consensus forecast of 4.5 percent* and The Conference Board’s forecast. Consumption growth drove the expansion (despite a contraction in real disposable income), but was supported by government spending and an expansion in private inventories. These data put a November Fed hike back on the table. While the prospects for a soft-landing for the US economy have improved, our base case forecast still calls for two quarters of contraction in early 2024.

Key takeaways from today’s report.

GDP data in Q3 2023 showed a number of important trends that we expect to evolve over the coming quarters. Following a lull in Q2, consumption growth came in much stronger in Q3. Growth in consumer spending on goods and (importantly) services both accelerated for the quarter. Despite these spending gains, real disposable personal income contracted by 1 percent for the quarter. This mismatch between spending and income is troubling. As pandemic excess savings are depleted, debt levels continue to rise, and mandatory student loan repayments roll out, we expect consumption growth to weaken and eventually dip into contractionary territory.

Today’s data also showed softer than expected growth in non-residential investment in Q3 (-0.1 percent, the weakest reading since Q3 2021). A contraction in business investment in equipment was a major driver of this weakness, but investment growth in intellectual property products and structures also came in softer than the prior quarter. High interest rates appear to be weighing on businesses’ willingness to borrow. Residential investment, on the other hand, had a better quarter and grew by 3.9 percent (the first positive readings since Q1 2021). Finally, private inventories saw a large expansion in Q3, which contributed 1.3 percentage point to overall GDP growth.

Today’s report puts a November Fed hike back on the table despite the softer tone from Chair Powell last week. Tomorrow’s Personal Income and Outlays report, which includes updated PCE inflation data (the Fed’s preferred inflation metric), may be the deciding factor. Watch for our note in these data tomorrow morning.

These and other recent data show that the US economy has been remarkably resilient to the duel stresses of high inflation and high interest rates. As inflation continues to cool it is possible that a soft landing may be achievable, but we continue to believe that a short and shallow recession is the more probable outcome.

The individual components of GDP were mixed.

Personal Consumption Expenditures (PCE) expanded by 4.0 percent for the quarter, vs. 0.8 percent in Q2. Demand for goods grew by 4.8 percent (vs. 0.5 percent in Q2), while demand for services grew by 3.6 percent (vs. 1.0 percent in Q2). Additionally, as we already have monthly spending data for July and August, these quarterly data imply that consumer spending was strong in September. We’ll learn more about this in tomorrow’s Personal Income & Outlays report.

On the investment side, nonresidential fixed investment contracted by 0.1 percent, vs. up 7.4 percent in Q2, due largely to weak investment in equipment for the quarter (-3.8 percent). Residential investment grew by 3.9 percent, vs. -2.2 percent in Q2. This was the first positive quarter since Q1 2021, but we don’t expect a sharp rebound in the sector. Private inventories expanded by $105 billion. This increase from $18.5 billion in Q2 resulted in a significant boost to US GDP growth of 1.3 percentage points.

Government spending was also a significant contributor to overall economic growth for the quarter, rising 4.6 percent, vs. 3.3 percent in Q2. The acceleration was due to increases in both federal defense and nondefense spending.

Net exports contributed -0.1 percentage point to overall GDP. Exports grew by 6.2 percent for the quarter while imports grew by 5.7 percent.

Finally, it is important to note that GDP data have undergone large revisions in recent quarters. For example, the advance estimate for Q1 2023 data was 1.1 percent, but was gradually revised up by more than a full percentage point to 2.2 percent. It is very likely that the final data for Q3 2023 will be quite different from these advance estimates.

* Consensus data from Bloomberg