GDP Returns to Positive Territory in Q3, but Underlying Growth Remains Weak Amid Housing Downturn

Key Takeaways:

• Gross domestic product (GDP), adjusted for inflation, increased at a 2.6 percent seasonally adjusted annualized rate (SAAR) in Q3 2022, ending a streak of two consecutive declines, according to the Bureau of Economic Analysis (BEA). Real personal consumption expenditures, the largest component of GDP, grew at a 1.4 percent SAAR, driven by a 2.8 percent increase in services consumption; real goods consumption declined at a 1.2 percent SAAR. The real trade deficit shrunk dramatically in Q3, adding 2.8 percentage points to GDP growth. Significant negative contributions to GDP included residential fixed investment, which fell by a whopping 26.4 percent SAAR, its sixth consecutive negative quarter and the largest decline since 2010 (excluding the initial COVID-shock period), and inventory investment, which subtracted 0.7 percentage points from headline GDP growth. Real private sales to domestic purchasers, a better indicator of underlying growth, rose 0.1 percent annualized, its worst quarter since the onset of the pandemic. 
• Personal Income, adjusted for inflation, was flat in September, according to the BEA. Real disposable personal income was also flat while real income excluding transfer payments rose 0.1 percent. The personal saving rate declined three-tenths to 3.1 percent. The Personal Consumption Expenditures (PCE) price index increased 0.3 percent and 6.2 percent annually, the same as in August for both measures. Core PCE increased 0.5 percent in September and was up 5.1 percent over the year, an acceleration of two-tenths from August.
• The Employment Cost Index (ECI), a measure of labor compensation, rose 1.2 percent in Q3 2022 according to the Bureau of Labor Statistics. The ECI has decelerated by one-tenth for each of the past two quarters.
• Durable goods orders increased 0.4 percent in September, according to the Census Bureau. Excluding transportation equipment, however, durable goods orders were down 0.5 percent and core capital goods orders (nondefense excluding aircraft) were down 0.7 percent.
• The Conference Board Consumer Confidence Index declined 5.3 points to 102.5 in October after two consecutive months of increases. Consumer confidence in the present situation fell 11.3 points to 138.9, the largest single month drop since December 2020, while expectations for the future were down 1.4 points to 78.1.
• New single-family home sales declined 10.9 percent to a SAAR of 603,000 in September, partially reversing a 24.7 percent jump in August, according to the Census Bureau. New homes for sale rose a modest 1.1 percent to 462,000, though the number of completed homes for sale jumped 19.1 percent to 56,000, the highest level since July 2020. The months’ supply increased by 1.1 months to 9.2.
• The National Association of REALTORS® Pending Home Sales Index, which records contract signings of existing homes and typically leads closing by one to two months, dropped 10.2 percent to 79.5 in September, the fourth consecutive monthly decline.
• The FHFA Purchase-Only House Price Index rose 11.9 percent compared to a year ago in August, a deceleration of 2.0 percentage points compared to July. On a seasonally adjusted basis, home prices declined 0.7 percent over the month.

Forecast Impact:

The rapid narrowing of the trade deficit boosted Q3 GDP to roughly its long-term average, largely in line with our expectations. While somewhat stronger than expected, personal consumption helped push GDP a touch higher than our forecast, and we continue to believe that the underlying growth trend is largely stagnant. This is consistent with real final sales to private domestic purchasers, the sum of private gross investment and personal consumption expenditures, slowing to 0.1 percent annualized growth in Q3 and averaging just 0.9 percent annualized growth over the year. Of course, this measure would have been stronger if not for the substantial decline in residential fixed investment (RFI), which has reacted sharply to rising interest rates stemming from persistent inflation. With mortgage rates eclipsing 7 percent for the first time since 2002 according to Freddie Mac, we expect this trend to continue. Due in part to falling RFI, poor consumer confidence, a likely weakening in consumption, a well-below normal saving rate, and a likely slowing to the pace of improvement in net exports, we continue to expect Q4 GDP to be modestly negative and for the economy to enter a recession in the first quarter of 2023.

The PCE price index failed to show significant improvement in September, though the slight deceleration in the ECI is a sign that wage growth has likely peaked. We continue to expect a 75-basis point hike to the federal funds rate next week.

New home sales resumed their downward trend in September after their jump in August, which we attributed to the brief pullback in mortgage rates over the summer. Notably, the number of homes for sale that were completed continued to rise steadily, suggesting an improving supply chain picture. This also suggests to us that builders may be increasingly willing to offer more aggressive incentives and discounts to maintain sales of completed inventory, putting further downward pressure on home prices, which declined for a second straight month in August. Additionally, pending sales accelerated their decline compared to August, supporting our forecast for the lowest existing home sales figure since 2010 and ongoing substantial declines in RFI.

Nathaniel Drake
Economic and Strategic Research Group
October 28, 2022

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