Strongest growth since 2021 puts Fed in tough spot

The U.S. economy likely expanded in the third quarter at the fastest clip in nearly two years, a surprising acceleration primarily powered by a consumer reaping the benefits of resilient job growth, rising wealth and easing inflation.

Gross domestic product is projected to have grown at an annual rate of 4.5% last quarter, more than double the pace in the prior period, according to a Bloomberg survey of economists ahead of the release of government data on Thursday. That would be the fastest pace since the end of 2021, when the economy was shaking off the effects of the pandemic.

"The U.S. consumer has been surprising most predictions, including the Federal Reserve predictions, which is almost looking for the U.S. consumer to soften, and yet they don't," Elie Maalouf, chief executive officer at InterContinental Hotels Group, said on the company's Oct. 20 earnings call.

The blowout quarter is good news for President Joe Biden, who's had trouble convincing Americans still hurting from persistent inflation that his economic policies are working. But it poses a bit of a quandary for Fed Chair Jerome Powell & Co.

In aggressively raising interest rates since March 2022, the central bank has been trying to quell inflation by dampening demand while avoiding a recession. While inflation has cooled as disruptions to global supply chains from the pandemic and the war in Ukraine have dwindled, U.S. domestic demand remains robust despite the Fed's efforts.

A strong job market is still propelling consumer spending, and business activity is gaining momentum. Additional signs of persistently strong growth "could put further progress on inflation at risk and could warrant further tightening of monetary policy," Powell said last week.

The Fed chief signaled that policymakers are likely to hold rates steady at their meeting next week, while leaving the door open to another increase in the future.

"He may not have a lot of patience if the growth numbers don't cool pretty quickly here," JPMorgan Chase & Co. chief economist Bruce Kasman said.

Slowdown ahead

Powell noted that forecasters generally expect growth to slow in the fourth quarter and next year after a "very strong" third quarter. Economists surveyed by Bloomberg earlier this month predicted that GDP will expand at an annual rate of just 0.7% this quarter, according to the median projection.

The trouble is that many forecasters — including those at the Fed — have been caught off guard by the economy's resilience in the face of the central bank's repeated rate hikes.

"You could have knocked me over with a feather, but it's where we are," said Diane Swonk, the chief economist at KPMG LLP, who's forecasting 5.5% third-quarter growth.

Consumers went on a spending spree from July through September as solid wage gains and ebbing inflation left them with more money to pay for goods and services. A record surge in household wealth coming into this year — courtesy of advances in home and equity prices — probably also played a part in encouraging consumption.

'Temporary boost'

Outlays may also have been boosted last quarter by spending stemming from concert tours by Taylor Swift and Beyoncé and summer blockbuster movies "Barbie" and "Oppenheimer," according to Bloomberg Economics chief U.S. economist Anna Wong. That won't be in play this quarter.

"A lot of this seems to be driven by consumer spending on discretionary items and discretionary services," said Yelena Shulyatyeva, senior U.S. economist at BNP Paribas SA. "We think that it's a temporary boost."

Also likely to be temporary: A forecasted decline in imports and a rise in inventories last quarter, two developments that economists say were surprising given the strength of consumer demand and are thus unlikely to be replicated in the final three months of 2023.

Housing is seen by some economists as having added to GDP last quarter after being a drag for over two years. But the renewed rise in mortgage rates in recent weeks on the back of climbing Treasury yields threatens to squelch the revival in residential investment.

"It's a short-lived bounce that's already reversing," Swonk said.

The economy will also face a number of other headwinds this quarter that it didn't in the prior three months, including the resumption of student loan payments after a pandemic pause and expanding strike by auto workers. Other risks include a possible government shutdown next month and the threat of a wider war in the Middle East.

Moody's Analytics chief economist Mark Zandi said he expects growth to slow to around 1% this quarter after coming in at 3.8% in the third.

Average them together and "it would be a good second half of the year, much closer to the economy's potential and much more consistent with a roughly stable unemployment rate," Zandi said. And that'd be more comfortable for the Fed, he added.