Economy still looks good on paper

January 30, 2025

Real GDP growth rose at a 2.3% annualized pace in the fourth quarter, close to our initial estimates but less than many market participants expected. Growth for the year came in at 2.8%, only slightly behind the 2.9% pace of 2023 and the third strongest annual pace since 2018. The economy continues to look better on paper than it feels to most Americans. However, those worries have not translated into weakness; just the opposite as consumers continue to drive overall gains.  

Consumer spending jumped 4.2% in the fourth quarter of 2024, one-half percent faster than the 3.7% pace of the third quarter. That is the fastest pace since the first quarter of 2023, when higher interest rates had yet to fully bite.

The biggest acceleration was in spending on big-ticket items and services. Vehicle sales hit their highest level since May 2021 in December due to replacement demand triggered by recent hurricanes. It is probably too soon to see the buying ahead of tariffs that many consumers said they were planning to do in the consumer sentiment survey for December. It was a record holiday travel season, with the largest number of people out on vacation we have ever seen. Travel from Thanksgiving to New Year’s Day hit records.

The support for spending came from wages, which continued to outpace inflation, a rise in net worth, a related drop in savings and replacement demand due to two monster hurricanes. Homeowners have been arbitraging the lower rates on home equity lines of credit rather than other forms of credit, notably vehicle loans, to support big-ticket purchases.

Residential investment rebounded modestly after contracting for two consecutive quarters. Lower interest rates late summer buoyed home sales, while home builders continued to offer incentives. Smaller builders are struggling; consolidation is expected to accelerate in 2025. We could get a bump in construction in early 2025 in response to rebuilding due to the devastation from hurricanes and fires, but affordability in the housing market remains near a record low.

Business investment contracted, largely in response to a strike in the aerospace industry. Equipment spending declined. Commercial real estate activity fell with the exception of investment in data centers and chip plants. Intellectual property investments moved up slightly.

Inventories plummeted, shaving nearly one percent from GDP alone. The economy would have exceeded the 3.1% pace of the third quarter if not for the sharp drain in inventories. Those losses were fueled by a strike in the aerospace industry and robust consumer spending on big-ticket items but set the stage for a rebuilding of inventories at the start of the year. Hence the strong core durable goods orders in December.  

Government spending rose 2.5% despite the constraints imposed by the continuing resolution, which caps much of spending at existing funding levels. Defense spending drove those increases as the outgoing administration rushed to get funds out the door, largely for Ukraine. State and local government spending slowed as a shortfall in fiscal 2024 tax revenues started to bite.

Finally, the trade deficit moved essentially sideways. Exports and imports increased only modestly. The trade deficit hit a record high for the year, which has become a flashpoint for the new administration.  

Inflation regained steam

The GDP and PCE deflators accelerated. The deflation in goods prices abated, while service sector prices continued to rise. This is one of many reasons that the Federal Reserve stepped to the sidelines and paused on rate cuts at its January meeting.