HIGHLIGHTS OF THE WEEK
- U.S. economic activity decelerated in the third quarter to a 1.9% annual pace from 2% in the second quarter, with consumer spending doing much of the heavy lifting.
- The Federal Reserve implemented its third, and likely final, interest rate cut of this year, citing muted inflation pressures and staid global developments. The bar for future rate cuts, however, has shifted higher
- PCE inflation continues to undershoot the Fed’s 2% target, with the headline measure at 1.3% year-on-year and core at 1.7%..
Consumers Step-Up, Businesses Pull-Back
The U.S. economic calendar was packed this week with several major data releases that gave a glimpse into the state of economic activity heading into the last quarter of the year. Kicking things off, the U.S. economy grew at a 1.9% annualized pace last quarter, slowing marginally from 2% recorded in the second quarter (Chart 1). Sectors centered on the domestic side of the economy, including consumer spending (+2.9%), residential investment (+5.1%), and government spending (+2%), all made positive contributions.
Other big entries did not fare as well. Most notably, business investment declined for the second straight quarter (-3%), while net exports and inventories were minor drags. The falloff in business spending is the worst performance since late 2015, reflecting a confluence of factors ranging from slowing global growth, rising trade protectionism, and elevated policy uncertainty to appreciation of the U.S. currency. On the flipside, residential investment, having declined for six consecutive quarters, finally returned to positive territory, spurred by falling interest rates and high demand for homes.
The consumer was once again the main driver of growth, and that bodes well for the economy if employers keep creating jobs and income growth remains steady. On the jobs side, the U.S. economy continues to surprise to the upside with non-farm payrolls rising by a healthy 128k in October, while job gains were revised upwards in the two prior months. However, a higher participation rate acted to induce a minor uptick in the unemployment rate to 3.6%. Overall, the labor market seems to be holding its own, even as the expansion cools. On the income side, average hourly earnings rose a decent 0.2% month-on-month in October (3% year-on-year). Other data releases showed that personal income advanced by 0.3% in September m/m, cooling from a 0.5% gain in August. Disposable income growth also slowed in September, weakening from 0.6% to 0.3%.
The headline PCE price index rose 1.3% y/y in September, while the core measure, the Fed’s preferred inflation gauge, was up 1.7% – well below its 2% target (Chart 2). This allowed the Fed ample room to implement its third consecutive quarter point cut, lowering the fed funds target range to 1.50%-1.75%. Although some easing bias remains, the accompanying policy statement signaled a higher bar for future interest rate reductions. The two previous cuts appear to be paying off by giving a lift to household spending in the most interest rate sensitive areas, such as housing and autos. This outcome has helped to offset a slump in manufacturing. Encouragingly, that slump eased a bit in October, with the ISM manufacturing sentiment index ticking up to 48.3 from 47.8 in September (see report).
Across the pond, Britain not only got a Brexit extension but also an early election. The Brexit deadline was extended to Jan. 31, while British lawmakers voted to hold a December 12th election. This paves the way for one of the most unpredictable and divisive national ballots in Britain, but inches the Brexit issue closer to resolution.
Overall, it appears a healthy jobs market, supported by monetary easing is keeping Americans spending (though with less gusto than before), and helping to make up for a shortfall in business investment.
Shernette McLeod, Economist | 416-415-0413
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