Fed's Rate Dilemma Intensifies As Hot, Steaming U.S. Economy Expands At Fastest Clip In 2 Years

The Fed's task is now cut out. The U.S. economy is chugging along at a fairly decent clip and the job market, the spotlight of the Federal Reserve in its monetary policy deliberations, is kicking into top gear. Can it take its next step toward monetary policy normalization in the current tightening cycle? A government data released a short while ago showed a buoyant domestic economy that is expanding at a run-rate above the norm.

However, the quality of growth could be of a cause of uneasiness, as exports and investment in inventory boosted the headline number even as consumer spending slowed.

The data may move some FOMC members who are not looking at an immediate move. This is in contrast to the message some Fed officials relayed last week.

The Numbers

Advance estimates released by the Bureau of Economic Analysis wing of the Commerce Department showed a 2.9 percent quarter-over-quarter expansion for the third quarter. This represented a pickup in pace from the 1.4 percent growth estimated for the second quarter.

Economists, on average, expected a 2.5 percent sequentially in the third quarter.

The third-quarter growth marked the strongest pace of expansion since the third quarter of 2014. On a year-over-year basis, GDP rose 1.5 percent vs. 1.3 percent expansion in the second quarter of 2016.

Commenting on the numbers, Mohamed El-Erian, chief economic adviser at Allianz, said., "At 2.9 percent, GDP growth for the third quarter bounced back stronger than consensus expectations. That's the good news, and it also speaks to the 75 percent probability of the Federal Reserve hiking rates this year (probably in December)."

He added, "Less good is that it looks like only a 1.5–2 percent GDP growth rate for 2016 overall. With a proper Congressional policy response, the economy is capable of higher and more inclusive growth."

Expectations Upbeat In Run Up To Data

Some data points released earlier this week raised hopes concerning the third-quarter numbers. Advance goods trade balance released last week showed that the goods trade deficit narrowed to $56.1 billion in September from a revised $59.2 billion in August, belying expectations for a widening of the deficit to $60.5 billion.

Thursday's durable goods orders report showed that core capital goods shipments, which is directly plugged into GDP calculations, rose 0.3 percent month-over-month in September.

Behind And Beyond The Numbers

Q3 GDP benefited from personal consumption expenditure, exports, private inventory investment, federal government spending and non-residential fixed investment, the BEA said. On the flip side, residential fixed investment and state and local government spending served a drags. Imports, a deduction from growth, weighed down by the virtue of its increase.

• Consumer spending, accounting for rough two-thirds of overall activity, rose 2.1 percent, although a slowdown from a 2.1 percent rate in the second quarter. Contribution form the metric slowed to 1.47 points from 2.88 percent.
• Gross private investment rebounded strongly, by 3.1 percent after faltering with a 7.9 percent drop in the Q2, and accounted for 0.53 points of the growth. Investment in non-residential structures bolstered the number. Residential investment continued to bleed, with a 6.2 percent drop.
• Exports climbed strongly with a 10 percent increase, against all odds of a global growth meltdown, and imports also increase, highlighting strong domestic demand.
• Government spending was also a positive.
• Inventories contributed to growth by 0.61 points after deducting from the growth in the previous quarter.

GDP Price Index

The GDP price index rose 1.5 percent year-over-year, slower than the 2.3 percent increase in the second quarter.

How U.S. Growth Stacks Up Against Others

Notwithstanding the robust economic momentum in the U.S., the growth trails the pace of expansion in some of the developing countries such as China and India. The hot and happening Chinese economy, the second largest in the world after the United States, has seen its growth momentum faltering in recent quarters, as the economy shifts toward domestic-demand driven from its over-reliance on external trade.

Nevertheless, earlier this month, China reported 6.7 percent year-over-year growth for the third quarter of 2016, the same rate of growth as in the previous quarter. This is a strong clip compared to the 1.5 percent rate for the U.S. economy.

The U.K. saw its economy expand at a fairly decent clip of 2 percent in the September quarter that immediately followed the Brexit vote.

The SPDR S&P 500 ETF Trust SPY was up 0.02 percent at 213.22 in pre-market trading Friday.

Image Credit: By Dan Smith - Own work, CC BY-SA 2.5, https://commons.wikimedia.org/w/index.php?curid=27323.