Consumer spending drives 3Q growth

October 30, 2024

Real GDP rose at a 2.8% annualized rate in the third quarter, slightly slower than the 3% pace of the second quarter. Consumer spending alone accounted for 2.5% of those gains. Wages continued to outpace inflation, wealth continued to accumulate, saving was drained and discounting picked up. Spending on goods accelerated with increased spending on big-ticket durable goods, many of which require financing; that outpaced other spending.

Some of the surge in consumer spending on big-ticket items reflected a catch-up in spending on vehicle sales early in the quarter, after dealers across the country were hacked and forced to delay sales to July from June. Older, wealthier homeowners have begun to tap the equity in their homes to upgrade and repair properties they either own outright or on which they are paying ultra-low mortgage rates. The push to age in place by baby boomers is a particularly sore issue for millennials waiting for more existing homes to be put up for sale.

A recent blog by the St. Louis Federal Reserve suggests that spending on electronics and appliances is holding up stronger than the data suggest due to shifts in where we buy those items. More are bought online and from big-box discounters instead of specialty stores.

Spending on services was strong, but lagged spending on goods. Revenge travel has receded, while a larger portion of consumer budgets is being allocated to cover housing and utilities. Spending on healthcare came in a distant second to spending on housing and utilities. Those two sectors alone accounted for over half of all service sector spending by consumers.

Residential investment contracted for the second consecutive quarter, which means the housing market slipped back into recession. Persistently high mortgage rates, acute supply shortages and a sharp jump in insurance and real estate taxes are all hurdles to affordability. Larger builders have been more flexible than smaller builders. They moved downscale and offered mortgage rate buy-downs to tap the pent-up demand from first-time buyers. That could trigger consolidation in the market, especially since mortgage rates have moved back above the 7% threshold over the last week.

Business investment remained tepid. A sharp increase in spending on new equipment was partially offset by a contraction in spending on new structures. The outliers show up in chip plants and data centers, which have expanded with subsidies and the push to train generative AI models. Investment in intellectual property remained almost flat during the quarter. An underestimate of the decline in prices of both software and hardware is likely understating the increase in business investment and, by extension, productivity growth in the economy.

The strike in the aerospace industry occurred late in the quarter but is ongoing and will have a larger impact on equipment shipments in the fourth quarter. It will take time well into the first half of 2025 to recoup what is lost in aircraft deliveries. Suppliers are feeling the pain along with large producers. The pandemic underscored how much easier it is to idle than to ramp up a plant after it has been shuttered for more than two weeks.

Inventories drained only modestly. Retailers attempted to hedge a port strike on the East Coast, which started on October 1. Negotiators returned to the table after only three days of striking. The next deadline is January 15. Dock workers’ biggest issue is automation, which would speed deliveries but force early retirements and layoffs. The rise of large containers at ports has already caused a major loss in the number of dockworkers at our ports since the 1960s; the number has fallen by more than 90% in recent decades.

Government spending accelerated in the third quarter, supported by a sharp increase in defense outlays. A combination of a late budget agreement – we did not get one until March – and our ongoing support for wars in Ukraine and the Middle East meant that more of the federal budget had to be spent prior to the end of the fiscal year, October 1. Defense outlays surged at a double-digit pace in the third quarter, the fastest since the fourth quarter of 2020. Congress does not return from recess until November 12 but is expected to cap fourth quarter spending with a continuing resolution.

Spending at the state and local levels held steady at a 2.3% pace in the third quarter, the same as the second quarter. However, that marks a sharp slowdown from what we saw in 2023 and early 2024. State and local government hiring, which helped to offset weakness elsewhere in the economy over the last 15 months, could fall short in the fourth quarter. Much of the COVID-era stimulus and transfers to the states have already been spent, while rainy day funds are being tapped.  

The biggest question mark is how much additional funding will be allocated to FEMA and transferred to states still cleaning up from two monster hurricanes. Many roads are still washed out in the wake of Hurricanes Milton and Helene. The damages to schools, businesses and households are still being assessed.

The trade deficit widened a bit. Exports and imports both surged at a double-digit rate after hardly moving in the second quarter. The sheer volume of imports outweighed the gains in exports. Hedging by retailers ahead of the threat of port strikes accounted for some of that strength. The US continues to outperform nearly all of its major trading partners, while a strong dollar is suppressing the price of imports.  

Inflation Decelerates

The GDP deflator, which is a broad measure of inflation, came in at a 1.8% pace, the weakest pace since the fourth quarter of 2023. A further deceleration in the fourth quarter would provide the Federal Reserve with more comfort that it is achieving the price stability it has been seeking.

Bracing for hurricane disruptions

The two monster hurricanes Helene and Milton did not hit until late September and early October. That means the bulk of the disruptions will not show up in the data until the fourth quarter. The employment report for October will be messy as more than 3.5 million households were still without electricity during the week of the monthly survey when rescue efforts were still underway.

The damages due to the hurricanes disrupted businesses and caused massive infrastructure damage across multiple states. Many temporarily evacuated from Florida to nearby states. Others are still in makeshift shelters due to the breadth of the devastation, especially in North Carolina. Congress will be asked to allocate more funds for long-term repairs. A surge in the damage due to natural disasters has limited insurance coverage and the extent to which we now rebuild. There is little doubt that repairs will increase materials costs and worker shortages.