Solid Output Growth in the Third Quarter
According to the advance estimate for third quarter real GDP, output growth slowed marginally, from 3.0% to 2.8% on a seasonally adjusted annualized rate. Real personal consumption expenditures increased 3.7%. Investment expenditures were weak, growing at 0.3%. Government consumption expenditures and investment grew at 5.0%, led by federal expenditures that grew at 9.7%, the largest since Q1 of 2021.
To better understand what drove the increase in real GDP, it is useful to look at what contributed to overall growth. To do so, the BEA essentially “weights” the change by the share in output. So, while consumption grew at 3.7% it constitutes about 70% of output. On the other hand, while federal government expenditures grew at 9.7% the share is only about 7% of the total. While consumption, government spending and exports increased their contributions to output growth, investment and imports decreased their contributions with imports being a drag on growth.
A MURKY Inflation Outlook
The recently released Personal Consumption Expenditure (PCE) index data sends a mixed message on inflation. Measured relative to a year ago, inflation is down, either from 2.27% to 2.09% for the PCE, or from 2.72% to 2.65% for core PCE (excluding food and energy). These are the numbers that have been making headlines. However, the monthly annualized inflation rate rose sharply, from 1.39% to 2.13% for the PCE, and from 1.89% to 3.09% for the Fed’s preferred core PCE measure. As we have said many times in the past, the monthly inflation numbers are quite volatile — as seen in the figures below. Meanwhile, the year-over-year measures take many months to reflect a change in trend. Our preferred trend measure splits the difference. By this measure, inflation rose in September, from 1.77% to 1.89% for the PCE, and from 2.26% to 2.53% for core PCE.
An Anemic Jobs Report
Employment in October increased by a scant 12,000 jobs. Indeed, the private sector actually shed 28,000. The labor market was roiled by weather and strikes, making it difficult to understand the stance of the labor market. Many economists “expected” a weaker report, something like 100,000 jobs, but note that the deviation from expected and actual is often quite large. To add to the dismal looking report, there was another 112,000 downward revision over the past two months. Average hours of work remained at 34.3 and average hourly earnings rose $35.33 to $35.46.
The household survey also showed some weakness, but keep the hurricanes and strikes in mind. The labor force fell 220,000 and the participation rate fell to 62.6 from 62.7. The number employed fell by 368,000 and there was a 150,000 increase in the number unemployed. The unemployment rate increased slightly, from 4.05% to 4.15%.
Policy Outlook
The real-side picture is mixed: a strongish GDP report, but a weak employment report. Abstracting from the strike activity affecting the employment numbers, the October reading for the labor market is still feeble, particularly compared to September’s strong report. Core PCE inflation is still running at least half a point above the Fed’s 2% target.
One way to try to make sense of all this is to look at the real Federal funds rate: that is, the nominal rate less inflation. The current target for the Fed funds rate is 4.84%. Core PCE inflation for October was 2.54% using our trend measure, or 2.65% as measured year over year. Consequently, the real Fed funds rate is 2.2-2.3%. Whether or not this value is considered high depends on what one things is the “natural” rate of interest: the rate that would prevail if the economy is operating at potential (full employment), and inflation is stable. If one puts credence in the estimates of the New York Fed, it is. So, then one must ask whether now is the appropriate time to continue loosening monetary policy. The answer to this question depends chiefly on: (1) whether one thinks enough tightening has been applied to bring inflation into a “glide path” to 2%; and (2) whether the real side of the economy is (starting to) display weakness. For our money, inflation is job one for the Fed, and there’s still work to be done.
