Halfway through the third quarter, the economy is looking surprisingly strong. A tracker from the Atlanta branch of the Federal Reserve has real gross domestic product growth, based on the limited data we've gotten so far, tracking at 5.8%, which would be the fastest for a non-pandemic quarter in 20 years. If the US keeps up this blistering pace, it would trump economists’ forecasts for every other major economy except India.
It wouldn’t be a shock, of course, if growth ultimately comes in lower than that, but it’s pretty clear at this stage that the third quarter really does look strong. How long can that be sustained? It’s likely that some of the factors boosting economic activity at the moment will abate by the beginning of 2024, but we should be left with an economy still growing at a reasonable pace.
There are four factors driving the Atlanta Fed’s lofty GDP estimate. The first is consumption, which is being boosted by two data releases: June’s strong personal spending report set a higher baseline for third-quarter spending and mechanically makes it likely that average consumption during the period will be greater than in the previous three months; and last week's robust July retail sales report, which suggested that spending momentum carried over into the first month of this quarter.
Beyond consumption, the Atlanta Fed tracker now projects that housing will be a positive contributor to GDP growth for the first time since the start of 2021 thanks to July's strong housing starts report. It also projects that inventories will add around 1% to GDP growth, which makes sense as companies restock their shelves after drawing down inventories for most of the past 18 months.
Finally, software and government spending are projected to be modest contributors to growth — software tends to add to growth outside of recessions, and the government should continue to be a tailwind for the economy for the next few years thanks to the policies passed in Washington under the Biden administration.
A lot of the growth we're seeing should have been anticipated since the second half of 2022. Back then, the housing market was retrenching as the huge rise in mortgage rates chilled buyers. And companies were drawing down inventory levels as consumers shifted their spending from goods to services in a post-pandemic normalization. Those seemed likely to reverse, at least somewhat, in 2023. Combined with prospects for the automobile supply chain healing, there was reason to think we'd get a burst of growth. It’s here now.
But just as there were reasons a year ago to think growth would pick up in 2023, there are now similar reasons to think growth will be slower in six months than it is today. First, rebuilding inventories tends to last no more than a couple of quarters. Maybe companies will still be increasing inventory levels in the fourth quarter, but this is merely part of the post-pandemic normalization process, not an environment where companies are looking to massively stock up.
Second, the normalization in the automobile supply chain is welcome, but more a one-off boost to growth than a dynamic that will be powering activity for quarters to come. And third, the recent rise in longer-term interest rates once again poses a threat to the housing market. Homebuilding stocks had their worst day of the year on Thursday — perhaps mortgage rates approaching 7.5% is the threshold that will cause homebuyers to pull back for a bit, limiting the boost to economic growth from residential construction.
These factors on the horizon — the end of the inventory build, automobile production and buying shifting from growth to stability, and housing construction stabilizing at higher levels than we saw at the end of 2022 — are more like tailwinds abating than headwinds gathering. Steady job and wage growth should continue to support consumption; and technology, clean energy, and government spending are still powering the economy. The outlook for the beginning of 2024 looks solid, just don't expect whatever eye-popping numbers we get in the third quarter to be the new normal.
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