US 3rd quarter GDP surged an annualized 5%, the strongest quarterly growth since the US economy grew 6.9% in the 3rd quarter of 2003. With the exception of inventories, which had virtually no impact on growth, nearly every category in the report was revised significantly higher from earlier estimates. Most significantly, personal consumption expenditures were revised from an annualized increase of 2.2% to one of 3.2%, accounting for 2.2 percentage points of growth. Business fixed investment jumped an annualized 8.9%, accounting for about 1.10 percentage points of growth, while a smaller trade deficit and government expenditures accounted for 0.80 and 0.70 percentage points of growth, respectively.
On the surface, this is an exceptionally strong report, suggesting that the US economy is hitting on all cylinders and approaching the ever elusive escape velocity. While the report is indeed a strong one, there are a few underlying facts that bear illumination. First, much of the strength in personal consumption was due to an enormous upward revision in healthcare outlays, which alone added 0.52 percentage points to GDP growth. In other words, healthcare outlays accounted for just over 10% of GDP growth during the quarter, or nearly 25% of the total contribution from personal consumption. Furthermore, it accounted for 65% of the entire revision to personal consumption from the prior estimate. This has been a volatile input all year, with revisions from the initial first quarter estimate through the third estimate responsible for much of the decline in first quarter GDP. Given the volatility around this input, it likely wasnt nearly as weak as the 1st quarter estimate suggested nor as strong as the subsequent two quarters would suggest.
Second, over the course of the GDP releases for the 3rd quarter, disposable personal incomes have been revised lower and spending has been revised higher, resulting in lower personal savings. While personal consumption grew an annualized 3.2% during the quarter, disposable personal incomes grew just 2%. Spending growth that exceeds income growth simply isnt sustainable. In fact, the savings rate of 4.7% ties for the second lowest since the recovery began. Bear in mind that the savings rate has also been inflated in the last year or two by an accounting change implemented by the BEA in which pension vesting accrues to personal savings. While this makes much sense from an accounting standpoint, this is certainly not savings in the traditional sense since it cannot be accessed prior to retirement without penalties. Under the previous methodology, the saving rate would be significantly lower. This suggests most consumers still have a razor thin margin of error.
Third, the 4.4% jump in government outlays is by far the largest since they grew 7.5% in the 2nd quarter of 2009. The increase was largely the result of a 16% jump in defense spending, far and away the largest such increase since a 17.4% rise in the 2nd quarter of 2009. Its a rather safe bet that this wont be repeated in the immediate future. Fourth, the benefit from a declining trade deficit is also unlikely to be repeated as a stronger dollar and weak foreign economies put a crimp in exports relative to imports.
Third-quarter GDP was strong with nearly all significant variable, except inventories, positively contributing to growth. However, its also very likely that a number of the strongest contributors provided far less spark in nearly completed current quarter. Its unlikely that healthcare, defense sending, or trade will contribute nearly as strongly as they did during the 3rd quarter, with the latter two actually likely to detract from growth. Inventories, as is often the case, will be a wild card. So while the US economy has performed far better than most expected after the final release of 1st quarter GDP in June, dont expect a repeat of the 3rd quarters performance in the 4th quarter.