Ever since the beginning of the Covid pandemic, the performance of the US economy has perplexed economists. 

At this time, with the US Fed having ratcheted up interest rates so rapidly, consumer price inflation seems to be really decelerating rather quickly.

Nonetheless, the US economy expanded at a faster than expected 2.9% annual rate in the fourth quarter of last year following a 3.2% gain in the third quarter. 

On the inflation deceleration side, the latest data are quite encouraging. 

The fourth quarter GDP report indicated that the personal consumption expenditures price index, a key inflation metric for the Fed, rose at an annualized 3.2% rate in the fourth quarter, down from a 4.3% pace in the previous three months, and its  slowest rate since 2020. The GDP price deflator also decelerated in the fourth quarter of last year. 

While signs of an economic slowdown this year are widely expected, many observers are still cheered by the economy’s continuing strong job performance, which seems to suggest that the coming weak phase will be a soft landing rather than an out and out recession.

Unfortunately, the data supporting the soft-landing scenario are somewhat suspect. In fact, the composition of US GDP growth in the fourth quarter provides a series of worrying signs on the spending front.  

As the following table indicates, roughly half of the increase in GDP in the fourth quarter was due to a huge $130 billion surge in inventories, which could signal a lot of unintended over stocking because of weakening sales. 

Indeed, US consumer spending in Q4 did slightly slow to a 2.1% annual rate from 2.3% in the previous quarter.  

Another part of the strong GDP expansion in Q4 was due to a 4.6% decline in imports, also not a sign of confidence in the economy. 

Finally, an important gauge of underlying demand that strips out foreign trade and inventories, the real final sales to private domestic purchasers, rose just 0.2% in Q4, the weakest expansion since the second quarter of 2020.  

Real final sales also expanded at a very weak 0.5% annual rate over the last nine months. As a recent National Bank Financial report observed, in 11 of the 12 previous instances when real final sales were this weak, the US economy was either in recession or about to enter one.  

Given the many signs of consumer and investment spending weakness just ahead, the Fed is clearly in a very difficult position if it raises interest rates further and/or keeps the current level of interest rates too high for too long. 

In other words, it is a bit of a toss up whether there really will be a soft economic landing for the US economy in 2023.  
 

US GDP Growth, Q4 2021 - Q4 2022 (Annual Rates)

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