US economy ends 2023 on a strong growth footing

A strong Q4 US GDP number to finish off 2023, with growth over the quarter posting a 3.3% increase to leave the economy expanding by 2.5% over 2023 as a whole, a modest increase on the 2.2% reading seen in 2022. Personal consumption – the main engine of growth in the US - was the biggest single contributor to the strong number, accounting for some 1.9% of the 3.3% gain, very much echoing the resilience that has been seen in the retail sales figures over the course of the year. But on top of this, strong performances in both trade and business investment also made significant contributions.

The strong performance in personal consumption is likely a direct result of the falling rate of inflation that is being seen, as well as the ongoing resilience of the labour market, both of which are likely boosting sentiment and in turn encouraging consumers to continue spending. The contribution made by business investment is probably the result of resources being poured into products such as electric vehicles and battery production, along with other green-related industries such as zero carbon energy production. The Inflation Reduction Act has been a key driver behind this performance. The report also showed that the inventory build-up seen in Q3 – and which was largely responsible for the 4.9% print seen – did not unwind as expected and therefore offered no drag on growth in Q4.

However, going forward, growth looks set to slow this year and the outlook for Q1 2024 is for a modest slowdown from the Q4 figure. The expected drag from inventories has likely been delayed rather than avoided, while weakening global demand means the boost from net exports seen in Q4 will not be sustained going forward. Legislation such as the CHIPS and IRA Acts will also not continue to boost growth; the huge surge seen in construction spending following the introduction of the CHIPS Act saw spending rise by 30.3% in Q1 last year, but which had already fallen to 11.2% in Q3 and to 3.2% in Q4. The level of spending remains elevated, but the actual growth rate is heading back to zero. But there is no suggestion that the economy is going to roll over and potentially contract; rather we see growth moving back in line with its long-term trend.

Lastly, the core PCE price index remained unchanged at 2.0% in Q4, meaning that the Federal Reserve (Fed) has now achieved its target on this measure for two consecutive quarters. If this stays at this level then it implies a real interest rate of around 3.25%, a level that is much too high and unsustainable economically, and meaning the Fed will need to cut rates unless it is convinced growth is going to unexpectedly surge higher or inflationary pressures are going to rebound again. There are no arguments or evidence for suggesting either of those things will happen, leaving the Fed in the position of needing to cut rates sooner rather than later if it is to avoid monetary policy exerting an unnecessary drag on growth. Accordingly, despite today’s strong growth numbers, interest rates still look set to be cut, and while we continue to favour May as the most likely date for a first move lower, a decision to soften policy in March still cannot be ruled out.