Fourth Quarter GDP and Employment Costs

Joel L. Naroff
President and Chief Economist

INDICATOR: Fourth Quarter GDP and Employment Costs
KEY DATA: GDP: +2.6%; 2014: +2.4%; Consumption: +4.3%; Consumer Inflation (Excluding Food and Energy): +1.1%
IN A NUTSHELL:   “Consumers are now leading the way and with confidence soaring and jobs plentiful, that is likely to continue.”
WHAT IT MEANS:  After two robust, and largely unsustainable, quarters of growth, it was expected the economy would moderate in the fourth quarter and that was what happened.  Of course, the deceleration was a bit greater than expected as most economists, including myself, were looking for 3% or more.  Critically, consumers are out there spending like crazy.  Consumption grew at the fastest pace in nearly nine years and there is still a lot of pent up demand out there.  But there were some weak parts of the report as well.  Business equipment investment dropped after two consecutive double-digit increases.  These data can be volatile, but with oil prices so low, it is likely that energy investment activity will take a hit for a while.  Slowing exports and rising imports don’t make for a good combination and the trade deficit widened, reducing growth by one percentage point.  That too could continue to occur over the next few quarters.  And finally, or as usual, the federal government continues to do its best to keep growth from accelerating.  Defense spending fell sharply, reducing growth by 0.6 percentage point.  Isn’t sequestration fun?  On the inflation from, there remains very little.  The Personal Consumption Expenditure deflator rose minimally, even excluding food and energy. 
Businesses continue to do a spectacular job of restraining labor costs as the fourth quarter Employment Cost Index increased at a slower pace than in the previous two quarters.  Wage gains decelerated, which was a real surprise given the tightening of the labor market and the growing number of job openings.  Either the labor market has been delinked from economic forces or the delay in raising wages will turn around sharply.  I have argued that would happen for months now and it hasn’t, so even I am beginning to wonder what is going on in this market. 
MARKETS AND FED POLICY IMPLICATIONS: The economy is in really good shape and the ebbs and flows in growth are nothing unusual.  This was the first estimate for GDP and we saw last quarter that the final number can be quite a bit different from the so-called “advance estimate”.  So let’s wait a couple of months before we decide upon how much growth actually moderated.  Even with the slowdown, the economy expanded at a 4.3% annualized pace during the second half of the year.  That is hardly chopped liver.  We should see solid growth this year.  The University of Michigan’s Consumer Expectations Index jumped in January, mirroring the Conference Board’s results.  Lower energy prices are really boosting confidence and that seems to be translating into more spending.  On the business side, the battle will be between uncertain energy producer investment and the capital needs of consumer-based companies. While energy sector spending may moderate initially, the companies must invest in cost cutting technologies so $45 /barrel is profitable.  That could raise spending in the future.  The big uncertainty is exports.  They have been decelerating and softer world growth implies further slowdowns.  That said, I still think growth this year could push 3.5%.

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