US Q3 FY16 GDP Grew 2.9% versus Forecasts of 2.5%

GDP gained on strength of consumer spending and a better performance in global trade

The US economy clocked a seasonally adjusted annual growth rate of 2.9% in Q3 FY16 versus forecasts for a 2.5% growth rate, according to the advance estimates released by the Bureau of Economic Analysis (BEA) on Friday, October 28th, 2016. The GDP saw an acceleration from Q2 FY16’s growth rate of 1.4% and the strongest since Q3 FY14, driven by the continued strength of consumers spending and a better performance in global trade. The BEA emphasized that the Q3 FY16 advance estimates released are based on source data that are incomplete or subject to further revision; the second estimate for Q3 FY16, based on more complete data, will be released on November 29th, 2016.u1

Reacting to the news, the dollar rose to a three-month high against the yen, while prices for U.S. government bonds fell. U.S. stock index futures were little changed.u2

The increase in real GDP in Q3 FY16 was due to positive contributions from personal consumption expenditures (PCE), exports, private inventory investment, federal government spending, and non-residential fixed investment, partially offset by negative impact from residential fixed investment and state and local government spending. The real GDP also grew at a robust pace due to higher exports, a smaller decrease in state and local government spending, and an upturn in federal government spending. These positives were partly offset by a smaller increase in PCE, and a larger increase in imports.

Slowdown in consumer spending

Consumer spending, which accounts for more than two-thirds of US economic activity, slowed down to 2.1% during Q3 FY16 from Q2 FY16’s robust 4.3% growth. Spending on durable goods remained strong, but growth in services spending slowed and purchases of non-durable goods declined at the steepest rate since the end of the 2009 recession. In all, personal-consumption expenditures added 1.47% to the quarter’s 2.9% growth rate for total GDP. With a tightening labor market generating steady increases in wages and strong household income, spending could accelerate in the upcoming holiday season.

Modest rise in business spending

Business spending rose modestly for the second consecutive quarter, with fixed non-residential investment rising 1.2% and contributing 0.15% to the GDP growth rate. Spending on structures and intellectual property products increased, but equipment purchases declined to 2.7% for the fourth consecutive quarter. While the pace of decline has been ebbing as oil prices stabilize and the dollar’s rally gradually fades, a strong turnaround is unlikely in the near-term. The Federal Reserve has highlighted soft business investment as a concern in recent months, attributing it to the weakness in the energy sector. On the other hand, investments in R&D and other intellectual-property products remained solid during and after the recession.

During Q3 FY16, labor costs rose 0.6% after a similar gain in Q2 FY16, leaving the Y-o-Y rate of increase at 2.3%. Businesses increased spending to restock after running down inventories in Q2 FY16. Businesses accumulated inventories of $12.6 billion in Q2 FY16, turning into a tailwind for Q3 FY16 growth, and contributing 0.61% to GDP growth.

Shrinking of trade deficit

A surge in soybean shipments propelled overall export growth to 10%, the biggest rise since Q4 FY13, and helped to shrink the trade deficit in Q3 FY16. As a result, net exports contributed 0.83% to GDP growth after adding a mere 0.18% in Q1 FY16. Imports rose at a more modest 2.3% in Q3 FY16.

Housing remains soft spot

During Q3 FY16, residential fixed investment declined for the second straight quarter, falling by an annual rate of 6.2%, following a 7.7% drop in Q2 FY16, and subtracted 0.24% from the overall GDP growth rate in Q3 FY16. Spending on non-residential structures, which include oil and gas wells, grew 5.4% in Q3 FY16, the fastest pace since Q2 FY14, after falling 2.1% in Q2 FY16.

Government spending mixed

Lastly, government spending presented a mixed picture, with a rise in federal-government spending contributing to growth, but offset in part by a decline in state and municipal spending. State and local governments in particular have pulled back on infrastructure spending and major capital projects. In all, total government spending added a modest 0.09% to Q3 FY16’s GDP growth rate.

While US GDP has not risen as per expectations, the Federal Reserve believes that it has been sufficient to kickstart an improvement in the labor market. Although the Federal Reserve is mostly focused on employment and inflation, signs of economic strength would likely strengthen the case for an interest rate hike in December 2016.

The Federal Open Market Committee (FOMC), which met last on September 20th-21st, 2016, in Washington, has deterred hiking interest rates at all six meetings so far during the year. The Fed last raised its target for the federal funds rate to a range of 0.25% to 0.5% in December 2015, after keeping the benchmark rate near zero levels for the past seven years. The focus now shifts to the Fed’s meeting on December 13th-14th, 2016, with economists predicting a 54% probability that the Fed will raise interest rates, depending on key economic parameters, inflation, and markets performance in the run-up to the presidential election.

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