US Economic Growth Likely Slowed in Fourth Quarter Despite Strong Domestic Demand

The US economy likely experienced slower growth in the fourth quarter, as reported by Reuters. A surge in imports and a strike at Boeing, which disrupted aircraft spending, contributed to the slowdown. However, robust consumer spending, fueled by a resilient labor market, suggests the Federal Reserve will maintain a gradual path of interest rate cuts this year.

The Commerce Department's advance gross domestic product (GDP) report, expected on Thursday, is anticipated to show consumer spending remained strong last quarter. This resilience is attributed to a robust labor market characterized by solid wage gains.

While the fourth-quarter growth rate is expected to be lower than the brisk pace seen in the third quarter, the economy defied predictions of a recession in 2023. This is despite the Federal Reserve raising interest rates by 5.25 percentage points over 2022 and 2023 to combat inflation.

The Fed, having reduced interest rates by 100 basis points since September, left its benchmark overnight interest rate unchanged at its latest meeting. It removed a statement indicating that inflation had "made progress" toward the Fed's 2% target.

Fed Chair Jerome Powell described the overall economy as "strong," though dissatisfaction with the economy contributed to President Donald Trump's election victory in November.

"The economy has done very well," said Brian Bethune, an Economics professor at Boston College, to Reuters. "Everybody has benefited, to some extent, but there still are some underlying issues in terms of distribution of employment, earnings and wealth."

Economists surveyed by Reuters forecast a 2.6% annualized GDP growth rate for the fourth quarter, down from the 3.1% pace in the third quarter. Estimates ranged from 1.7% to 3.2%. However, this forecast was made before data revealed a record high goods trade deficit in December, prompting the Atlanta Fed to slash its GDP forecast to 2.3%.

The full-year GDP growth is estimated at 2.8%, slightly higher than the 2.9% growth in 2022. This is well above the 1.8% non-inflationary growth rate deemed acceptable by Fed policymakers.

The Fed has projected only two rate cuts this year, a significant reduction from the four projected in September when its easing cycle began. This shift reflects uncertainty surrounding the economic impact of the new Trump administration's fiscal, trade, and immigration policies, which economists view as inflationary. They expect economic growth to weaken in the second half of 2024 and inflation to rise.

"Light touch regulation coupled with a low tax environment should, in theory, be supportive for the growth story," said James Knightley, chief international economist at ING, to Reuters. "But at the same time... tariffs are going to put up costs for the U.S., especially the consumer, disrupt supply chains as well. There is going to be a disruptive impact on the U.S. economy that will act as a brake on economic activity."

Anticipation of tariffs and a port strike led to a surge in imports during November and December, significantly widening the trade deficit. Economists estimate this likely reduced GDP by as much as a full percentage point, extending the trade drag on GDP to four consecutive quarters. Much of this imported goods were quickly purchased by consumers, potentially leading to lower-than-expected inventory accumulation by businesses.

Inventories likely acted as a drag on GDP for the second consecutive quarter. Trade and inventories, the most volatile GDP components, were likely offset by strong consumer spending growth. Consumer spending, representing over two-thirds of the economy, is expected to have maintained much of its third-quarter momentum, when it grew at a 3.7% rate. However, a strike by Boeing factory workers, which disrupted aircraft production and delivery, likely dampened business spending on equipment. This is despite robust growth in spending on intellectual property products driven by the AI spending boom.

Economists suggest focusing on final sales to private domestic purchasers, excluding inventories, trade, and government spending, to assess the health of the economy. This measure of domestic demand is projected to have grown closer to the third quarter's 3.4% pace. Inflation likely increased in the fourth quarter.

Residential investment likely rebounded, but rising mortgage rates remain a hurdle. Government spending growth was likely moderate, although the outlook is uncertain given the Trump administration's planned spending cuts.

"I look for the growth rate of real government spending to continue to narrow going forward," said Stephen Stanley, chief U.S. economist at Santander U.S. Capital Markets, to Reuters. "Much depends on whether the attempts by the new Trump administration to clamp down on federal spending bear fruit or are stymied by Congress and/or the courts."