Robust capex drives solid GDP
Fed may remain vigilant.
Bottom line
Driven largely by strong corporate expenditures (capex), personal consumption and state and local government spending, U.S. GDP rose by a better-than-expected 2.4% annualized rate in the second quarter, up from 2% in the first quarter of 2023. The Atlanta Federal Reserve’s “GDPNow” estimate was spot on; Bloomberg and Blue-Chip consensus forecasts were 1.8% and 1.3%, respectively; and our estimate here at Federated Hermes was 1.7%.
What happened? Capex was by far the strongest culprit category, rising 7.7% quarter-on-quarter (q/q) annualized. That accounted for nearly a full percentage point of the quarter’s overall growth, due to solid gains across the board in structures, equipment and intellectual property. Personal consumption rose by a better-than-expected 1.6%, but that was well below the first quarter’s robust 4.2% increase, as the consumer has begun to slow in recent months. Paced by state and local spending, government consumption added nearly a half point to overall growth. Inventory restocking rose modestly.
On the negative side of the ledger, net trade detracted moderately and residential construction was a drag for the ninth consecutive quarter.
Private domestic final sales strong This metric gauges the economy’s underlying fundamental strength because it excludes volatile inventory liquidation or restocking, net trade, and government spending. It rose by a solid 2.3% in the second quarter, compared with 3.2% in the first quarter, marking the strongest back-to-back gains since 2021. In our view, the odds of a soft landing have risen—and the risk of a recession has fallen— over the past six months.
Inflation continues to decline The core Personal Consumption Expenditure (PCE) index (the Fed’s preferred measure of inflation) slowed to a less-than-expected 4.1% y/y rate of growth in June 2023, down from its February 2022 peak at 5.4%, a 39-year high. In its latest Summary of Economic Projections (SEP) in June, the Fed projected that persistent core PCE will fall to 2.2% by the end of 2025.
So what’s the Fed’s blueprint now? Inflation continues to slow gradually, but it will likely be some time before the Fed can declare “mission accomplished.” In addition, initial weekly jobless claims hit a five-month low yesterday at 221,000, so the labor market remains tight.
Given the combination of solid economic growth, a healthy labor market, and sticky core inflation, the Fed hiked interest rates on Wednesday by another quarter point, raising the upper band of the fed funds rate to 5.50%. That’s the highest level in 22 years, and its pace of rate increases over the past 16 months is the most rapid since Fed Chair Paul Volker in the early 1980s. Given its more recent focus on the long and variable lags associated with monetary policy, the Fed may well pause again at its next meeting on September 20, but hike rates again—if warranted—on November 1.
Here are the details on the second-quarter GDP report:
Personal consumption (70% of GDP) rose by a better-than-expected 1.6% in the second quarter (accounting for 1.12 percentage points of the gain in overall GDP), versus consensus expectations for a softer 1.2% increase. That compares with a much stronger first-quarter gain of 4.2%. Spending on services (up 2.1%) tripled that on goods (up 0.7%) in the second quarter.
After a strong January 2023 (probably due to the historic 8.7% increase in Social Security payments) retail sales have been tepid over the past five months. The personal savings rate has risen from a 17-year low of 2.7% in June 2022 to 4.3% in June 2023, as consumers are building dry powder. In addition, excess savings have plunged from a peak of $2.3 trillion in September 2021 to $370 billion in June 2023. With student loan payments re-starting in October, personal consumption could slow further in coming months.
Corporate nonresidential capital spending soared by 7.7% in the second quarter (adding 99 basis points to GDP), versus 0.6% in the first quarter. After six consecutive quarterly declines, structures rose for the third consecutive quarter by 9.7% (adding 26 basis points), compared with a 15.8% first-quarter gain. Equipment spending rose for first time in three quarters, surging by 10.8% in the second quarter (adding 53 basis points), versus an 8.9% decline in the first quarter. Intellectual property spending grew by 3.9% for the tenth consecutive quarter (adding 21 basis points), compared with a 3.1% first-quarter gain.
Inventories rose by $9.3 billion in the second quarter on a chained-dollar basis, which added 14 basis points to overall GDP growth. That compares with a tepid $3.5 billion inventory restocking in this year’s first quarter.
Government spending rose for the fourth consecutive quarter (after five consecutive negative quarters) by 2.6% in the second quarter (adding 0.45 percentage points to overall GDP), compared with a 5.0% first-quarter gain. Federal spending grew by 0.9% in the second quarter (adding 6 basis points to growth), versus a 6% increase in the first quarter. State and local spending rose by 3.6% in the second quarter (adding 39 basis points), versus a 4.4% first-quarter gain.
Residential construction fell 4.2% in the second quarter (which reduced growth by 16 basis points), marking its ninth consecutive quarter of declines. But the recent pace of decline has been more modest this year, after horrific declines over the final nine months of 2022, so the housing recession is getting less bad. Mortgage rates more than doubled from 3% to 7.35% over the past 18 months, new and existing home prices spiked by 50% during 2021 and 2022 to record highs, and affordability plummeted to its worst level since 1986. But there is still tremendous pent-up demand among potential home buyers, with an estimated inventory shortage nationally of perhaps four to five million units. So if mortgage rates and prices ease at some point, housing activity will likely improve.
Net trade subtracted 12 basis points from overall growth in the second quarter. Despite the relative second-quarter weakness in the dollar against the yen, pound, and euro (which make our exports cheaper), exports declined by -10.8% in the second quarter (which reduced GDP by 1.28 percentage points), versus an increase of 7.8% in the first quarter. Imports fell 7.8% in the second quarter, which added 1.16 percentage points, compared with a 2% increase in the first quarter.