The American economy is still growing, but not for the reason you think

October 27, 2022, 7:37 PM UTC
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After the U.S. economy contracted for the second consecutive quarter this summer, most Americans believed that a recession was here—even if economists weren’t so sure.

But this week, despite persistent inflation and recession predictions from Wall Street, a new trend has emerged.

U.S. gross domestic product (GDP), the most common measure of economic growth, jumped 2.6% in the third quarter, the Bureau of Economic Analysis reported on Thursday.

President Biden was quick to take a victory lap after the report came out.

“For months, doomsayers have been arguing that the U.S. economy is in a recession,” he tweeted. “But with today’s third-quarter GDP report, we got further evidence that our economic recovery is continuing to power forward.”

But while GDP certainly recovered in the third quarter, when you break down what caused the jump, the outlook for the economy becomes far less optimistic.

The latest GDP numbers reflect a 14.4% surge in exports and a 6.9% drop in imports, which caused the U.S. trade deficit to drop dramatically, adding roughly 2.8 percentage points to GDP growth. 

The increase in exports was a result of supply chains uncoiling, and the U.S. sending record volumes of oil, petroleum products, and natural gas to Europe amid the continent’s energy crisis, according to Bill Adams, Comerica Bank’s chief economist. And the decline in imports was caused by Americans spending more on services and less on goods, while U.S. retailers pulled back on spending owing to swollen inventories and recession fears.

“The U.S. economy has continued to weaken, but once again, the top-line GDP number is hiding some of this weakness,” Raymond James chief economist Eugenio Alemán told Fortune. “The Federal Reserve should look at this report with caution and remain mindful of the underlying trend for U.S. economic growth, which shows a weakening economy.”

Alemán noted that in the first and second quarters of this year, GDP growth was pulled down by an increasing trade deficit—a major difference compared with this quarter. 

“While GDP was a little better than expected, the underlying trend of economic activity continues to slow,” Adams told Fortune. “The economy will likely cool further near term.”

A few more telling stats

While the headline GDP number shows the U.S. economy was resilient in the third quarter, some economists point to other key statistics that may give a better picture of underlying economic strength.

Real final sales to domestic purchasers, which is used to gauge demand without the impact of the trade deficit, only creeped forward by 0.1% in the third quarter. That’s down from 0.5% in the second quarter and 2.1% in the first.

Residential investment, or purchases of private residential structures and equipment, also sank 26.4% as higher interest rates continue to batter the housing market.

And finally, the personal savings rate, which represents how much disposable income consumers are able to save, dropped to just 3.3% in the quarter. That’s well below the nearly 9% historical average from between 1959 and 2022, and is even closing in on the record low of 2.2% seen in July of 2005.

Bank of America’s chief U.S. economist, Michael Gapen, said in a Thursday research note that he believes falling domestic demand, residential investment, and personal savings are a few of the examples that show “the domestic economy is in a growth recession”—a period of positive but below-trend growth.

Starting in July, Gapen predicted that the economy would fall into a full-fledged recession sometime this year, but in September he updated that outlook, arguing a “mild recession” won’t hit until next year. And today, he wrote that Thursday’s GDP report confirmed his new theory. 

Gapen now expects GDP growth to remain positive next quarter, at 0.5%, but by the end of next year he believes it will drop to negative 0.8%.

Morgan Stanley’s chief U.S. economist, Ellen Zentner, said in her own Thursday research note that the third quarter will “mark the peak in quarterly growth, as the cumulative effect of tighter monetary policy begins to push growth below potential.”

Some good news on the inflation front

While the latest GDP report isn’t nearly as strong as it looks on the surface, there was one key positive underlying trend.

The personal consumption expenditures (PCE) price index, a measure of inflation commonly used by the Federal Reserve, increased just 4.2% this quarter, compared with 7.3% last quarter. And even excluding more volatile food and energy prices, the PCE price index slowed, rising 4.5%, compared to 4.7% last quarter.

“This is another sign pointing to the likelihood that the worst of inflation may be behind us,” Cliff Hodge, chief investment officer for Cornerstone Wealth, told Fortune. 

But although inflationary pressures may be easing, the resilience in the U.S. economy seen in the third quarter will likely keep the Fed locked in its battle with inflation—and that could be bad news for the economy in the long run.

“Despite the slowdown in inflationary pressure during the quarter, the report should support the Fed’s plans for an additional 75 basis point hike at their November meeting,” Sam Millette, fixed income strategist for Commonwealth Financial Network, a registered investment adviser broker-dealer, told Fortune. “The economy showed impressive resilience during the third quarter despite Fed efforts to slow activity through tighter monetary policy.”

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