Economy Commentary

Well, That Didn’t Last Long, Did It?

November 2023

On October 26, the Bureau of Economic Analysis (BEA) released their initial estimate of Q3 GDP, which showed real GDP grew at an annual rate of 4.9 percent during the quarter, with consumer spending, government spending, and a faster pace of nonfarm business inventory accumulation the main drivers of growth. The initial print on Q3 real GDP growth fell right in line with what had been a firmer tone, at least on the surface, of much of the economic data. As we saw it, there were two alternative views of how to interpret the robust Q3 growth. One interpretation was that the economy was largely immune to the effects of higher interest rates, and what many for some time saw as an inevitable recession was off the table. The alternative take was that the burst of growth seen in Q3 was unsustainable, largely a function of one-off supports that would quickly fade and that, while perhaps less probable, recession was still a possibility in the not-too-distant future. We lean more toward the latter than the former interpretation, and we’ve been clear in our view that the pace of economic activity would slow sharply over the final quarter of 2023.

While it is far too soon, at least in terms of the flow of Q4 economic data, to draw any meaningful conclusions, the initial batch of data suggest Q4 growth got off to a very slow start. After the Institute for Supply Management’s (ISM) September survey offered glimmers of hope that conditions in the factory sector were at least beginning to stabilize, the October survey was more of a cold slap in the face. The ISM Manufacturing Index fell to 46.7 percent in October from 49.0 percent in September, indicating a twelfth straight month of contraction. The details beneath the headline index were even more bleak. For instance, the index of new orders, an important forward-looking indicator, tumbled to 45.5 percent in October after having flirted with the 50.0 percent cut-off point between contraction and growth in September, with only three of eighteen industry groups reporting growth in new orders. At the same time, October was the thirteenth straight month in which backlogs of unfilled orders contracted, which is important in that contracting new orders and thinning order backlogs set up a weak profile for production and employment. To that point, while the ISM’s gauge indicated factory sector employment fell in October, we found it much more telling that ISM reported that firms were more aggressively using layoffs to manage head counts, “indicating a more urgent need to reduce staffing.” All in all, there are few signs that stability, let alone growth, is readily within reach in the manufacturing sector.

While the ISM Non-Manufacturing Index indicates the expansion in the broad services sector continued in October, it also shows the pace of that expansion slowed meaningfully, with the headline index falling to a five-month low of 51.8 percent. One striking detail of the October data was that export orders abruptly contracted after having grown steadily over the prior several months. This suggests that tepid global growth is finally starting to take a toll on activity in the broader services sector after having for months been a drag on activity in the U.S. manufacturing sector.

The Bureau of Labor Statistics (BLS) reported that nonfarm payrolls rose by 150,000 jobs in October, with private sector payrolls up by just 99,000 jobs and public sector payrolls rising by 51,000 jobs. At the same time, prior estimates of job growth in August and September were revised down by a net 101,000 jobs for the two-month period. The bulk of that downward revision came from private sector payrolls, continuing a string of downward revisions to the initial estimates of private sector job growth. One important caveat is that the UAW strike deducted roughly 34,000 jobs from manufacturing payrolls in October, as striking workers are not counted as employed under the BLS’s reporting conventions. With the strike having been settled, pending ratification of the proposed contracts, those jobs will be added back in the November data.

Even allowing for the impact of the UAW strike, the details of the October employment report were glaringly weak. The one-month hiring diffusion index, a measure of the breadth of hiring across private sector industry groups, fell to 52.0 percent, the lowest reading since April 2020, and furthering a trend that has seen job growth become meaningfully less broad based across industry groups. To that point, hiring in health care accounted for almost all private sector job growth in October. The average length of the workweek declined by one-tenth of an hour in October. While a decline in hours worked in durable goods manufacturing was to have been expected given the impacts of the UAW strike, several other industry groups reported declines in average weekly hours. Hours worked have been drifting lower over the past several months, consistent with slowing, not accelerating, economic growth. The unemployment rate rose to 3.9 percent in October, and there were more people involuntarily working part-time due to slack business conditions.

As we noted above, with only a few data points for October to go on, it is far too soon to draw any meaningful conclusions regarding Q4 growth. That said, the few data points we do have at our disposal suggest a marked slowdown after the blistering pace of growth seen in Q3. And, while we may not be willing to draw conclusions at this point, market participants are showing no such reservations. Within a matter of a few days, much of the recent run-up in longer-term interest rates (which we discussed last month) was reversed and, after seemingly having finally accepted the FOMC’s “higher for longer” premise, market participants are now expecting a more aggressive course of Fed funds rate cuts in 2024 than had been the case just a few weeks ago.

The FOMC will be taking notice not only of the recent declines in longer-term interest rates but also of the recent easing in overall financial conditions. Some Committee members had implied that tighter financial conditions may effectively substitute for additional funds rate hikes, so it would follow that a meaningful easing in financial conditions puts further rate hikes back on the table. While we still see further rate hikes as unlikely, at the very least easing financial conditions would seem to push rate cuts further out into the future as long as inflation remains well above the FOMC’s target rate. With the economic data all over the map and the markets and the FOMC not on the same page, about the only thing we can confidently predict at this point is that equity prices and market interest rates will remain volatile in the weeks ahead.

Sources: Bureau of Economic Analysis; Bureau of Labor Statistics; Institute for Supply Management
As of November 8, 2023


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