This Week's State Of The Economy - What Is Ahead? - 28 October 2022

By: Taro Chellaram /Wells Fargo Economics & Financial Report/Oct 31, 2022

This Week's State Of The Economy - What Is Ahead? - 28 October 2022

Headline GDP continues to send mixed signals on the direction of the U.S. economy. During Q3, real GDP rose at a 2.6% annualized rate, ending the recent string of quarterly declines in growth registered in the first half of 2022. At first look, the expansion in real GDP is a welcome sign that the economy is busting out of its recent slump. The underlying details, however, paint an entirely different picture. The top-line real GDP figure was boosted by a 2.8 percentage point contribution from real net exports. Real exports of goods and services rose solidly during the quarter. Considering the current strength of the U.S. dollar and the economic struggles of America's trading partners, the strong growth in exports is unlikely to be sustained. On the other hand, real imports pulled back in Q3 as supply chains continue to normalize, businesses slow inventory builds and consumer demand wanes.

Taken together, consumer spending and business fixed investment, which are a better measure of the underlying trend in economic activity, were essentially flat during Q3. A sharp drop in structures spending dragged down overall business fixed investment, which fell 4.9% during the quarter. New nonresidential development continues to be hampered by uncertain demand and rising building material prices. Equipment and intellectual property spending both expanded solidly. The impacts of higher interest rates as well as the return to more typical consumer behavior were evident in the consumer spending data. Real personal consumption expenditures (PCE) registered a relatively soft 1.4% annualized rise. The quarterly gain was mostly the result of a solid increase in services spending, which is still benefiting from unleashed pent-up demand from the pandemic. Spending on goods, which is more sensitive to interest rates, declined for the third straight quarter.

Housing is another sector that is highly responsive to financing costs. Residential fixed investment plummeted 26.4% during Q3, a sharp decline brought on by this year's spike in mortgage rates. Since the start of the year, mortgage rates have moved up rapidly and are currently hovering above 7.0%. The climb in borrowing costs has significantly reduced affordability and pushed buyers to the sidelines. If October's drop in mortgage demand is any indication, residential fixed investment is likely to remain a drag on overall GDP. Mortgage applications for purchase have slipped in every week so far in October and are down almost 42% over the year. Pending home sales and new home sales are also on a steep downward trend, with both retreating markedly in September. Home prices are now declining on a monthly basis. The S&P Case-Schiller National Home Price Index dropped 1.3%, the second straight monthly decline.

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