Big Questions

As expected, the advance estimate of 3Q21 Gross Domestic Product showed a sharp slowing in growth. More timely data suggest that the economy regained some momentum into early 4Q21. Still, there are important questions regarding the labor market, inflation pressures, and Federal Reserve policy over the near term.

Real GDP rose at a 2.0% annual rate in the third quarter. A slower rate of inventory reduction added 2.1 percentage points. Final Sales (which excluded the change in inventories) fell at a 0.1% pace, but that was held back by a wider trade deficit. Domestic Final Sales (which excludes net exports) rose at a 1.0% annual rate. The government contribution to GDP is government consumption and investment (goods and services, such as military aircraft, education, and so on), not transfer payments (unemployment benefits and other transfers add indirectly to GDP growth, but not directly through the government component of GDP). If we exclude government, we’re left with Private Domestic Final Purchases, the real meat and potatoes of the economy – up at a 1.1% annual rate. Consumer spending rose at a 1.6% annual rate (vs. 11.7% in the first half of the year), while business fixed investment rose 1.8% (vs. +11.1% in the first half). Certainly, some moderation in these key GDP components was expected after the blistering pace of the first half of the year, but the slowdown was more than anticipated. Yet, that softness can be pinned on the rise of the Delta variant, which dampened the recovery in services, and the semiconductor issue in autos (final sales of motor vehicles fell at a 51.9% annual rate. September personal spending figures and the early retail sales info for October point to a pickup in 4Q21. Residential fixed investment fell at a 7.7% annual rate (+5.5% y/y), reflecting supply constraints.

The Employment Cost Index is the preferred measure of labor cost pressures. Average hourly earnings suffer from compositional changes, such as faster or slower growth in lower-paying jobs, while the ECI keeps the composition steady and includes benefits costs. For private-sector workers, the ECI rose 1.4% in the three months ending in September, up 4.1% y/y (vs. 3.1% y/y in June and +2.4% y/y a year ago). That’s certain to get the Fed’s attention. Depending on how much firms can pass along higher labor costs (and pricing power varies considerably across industries), this will add to inflation pressure.

Supply chain difficulties have been made worse by the shift in demand from services to goods, which now appears to be longer-lasting. Spending on goods was expected to wane as services recovered, and that may still happen. The Delta variant likely prevented many from spending on close-contact services, but many are likely to remain reluctant even after COVID cases fade. There isn’t likely to be much of a reprieve in the demand for goods in the near term.