A Chequer-Board of Nights and Days

Economists had widely expected that the pace of U.S. economic growth would slow, but not by this much. The advance U.S. gross domestic product report for the third quarter, released on Oct. 27, showed a relatively anemic annual growth rate of 1.6%, confirming market whispers that growth would hit what traders call the "1-handle" (i.e., below 2.0%). The median forecast of economists had called for growth of 2.3% following the 2.6% gain in the second quarter.

The surprisingly soft third-quarter figure was due largely to greater than expected weakness in business investment, both via the equipment and software spending components of the report and its measure of business inventories. The pattern was also evident in the construction sector, as nonresidential construction rose "only" 14%, vs. Action Economics' 22% estimate.

The shortfall in state and local government spending--with growth of only 2.1% despite a solid runup in public construction as we entered the quarter--could be seen as an investment shortfall as well. Residential construction was actually slightly stronger than expected, with a drop of "only" 17.4%.

Other component data in the third-quarter GDP report came in as expected, with the restrained 1.8% chain price gain that we had anticipated, alongside a 3.1% growth rate for consumer spending that was right in line with our estimate. The personal consumption expenditures (PCE) chain price index, an inflation gauge followed by the Federal Reserve, revealed growth of 2.5% in the third quarter, following the 4.0% gain in the second.

The report also showed a 1.7% growth rate for federal government spending. Net exports subtracted $15.7 billion from GDP following the $12.4 billion addition in the second quarter.

Equipment and software spending rebounded 6.4% following the 1.4% decline in the second quarter. The equipment figures have been volatile relative to forecasts since the fourth quarter of last year, and the third-quarter data extended the pattern, coming in well below our 10% forecast.

If inflation remains in check, the Fed may wish to see if it can continue to keep interest rates stable, or perhaps even drop them a quarter of a point. It may be necessary to augment GDP growth in coming quarters, though I imagine that the upcoming Christmas shopping season will help in that regard as well.