Real GDP growth disappointed, falling short of the 3.0% threshold and growing at a 2.8% rate in the fourth quarter. Sharp declines in both federal (defense spending), in addition to state and local governments, were the primary drag on growth. Both consumer spending and business investments were also more tepid than many expected. The big boost to growth came from a rebuilding in inventories, which is more backward than forward looking because it represents a catch-up from earlier shortfalls in production, most notably in the auto sector. Indeed, the rise in inventories (as opposed to underlying domestic demand) accounted for nearly 2.0% of the 2.8% rise in the economy we saw in the fourth quarter. We also saw a small increase from the housing market, but that is coming off of extremely low levels.
Consumers were particularly cautious in how they spent on services, which tend to be more discretionary than other types of spending. One of the largest shifts is occurring in spending on medical services. Elective surgeries, in particular, are being postponed or skipped entirely as consumers continue to deleverage.
On the corporate front, investment was almost nonexistent. A sharp drop in investment in new structures offset a moderate 5.2 increase in spending on new machinery. This follows double-digit gains in the third quarter and underscores an area of concern for the Federal Reserve. We need to invest more aggressively in our future to maintain our competitiveness and ensure a more robust and self-sustaining recovery.
Separately, the gains we saw all occurred against a backdrop of moderating inflation. Commodity prices moderated along with goods and service prices. Indeed, many of the gains we that we saw during the holiday season came at the expense of retail margins; retailers were forced to offer even more aggressive discounts this year than last year during the holiday season.
Bottom Line: The stage is set for a significant slowdown in growth from the fourth to the first quarter, as inventories recede to more “normal” levels. The hope is that business investment will pick up a bit, especially in light of December’s increase in capital equipment orders. The Fed appears to be validated, however, in its concerns about the outlook for the economy and using communications as a tool to stimulate further.