8 mins read . 23 Dec 2022
There is good news on the US real GDP growth front. According to the US Bureau of Economic Analysis (BEA) final estimates, the Q3 GDP for the quarter ended September 2022 saw the US economy growing at 3.2%. Now, why is this an upgrade? The US BEA typically puts out 3 estimates for the GDP each quarter, with the third and final estimate being most reliable. For September 2022 quarter the first estimate of US GDP growth had been pegged at 2.6%, second estimate at 2.9% and now the third estimate has come in at 3.2%. This growth is all the more significant as it comes after 2 consecutive quarters of GDP contraction in the March and June 2022 quarters. It may be recollected that in Q1 and Q2, the US GDP had contracted by -1.6% and -0.6% respectively on a yoy basis. This rebound does give us a hint that the recession risk may not really be a serious risk for now.
To give a macro picture, out of 22 sectors identified by the US-BEA, 16 sectors showed positive growth while 6 sectors showed pressure. Here is what we read from the US GDP data final estimates for Q3.
a) The big thrust to US GDP growth in Q3 came from private services which grew by a healthy 4.9% in the September quarter. With the private services sector, the boost came from information, professional services, scientific services, rentals and leasing. However, utilities and financials were under pressure.
b) On the government contribution to GDP, local and state governments made a positive contribution while Federal government applied pressure. However, private goods continued to be under pressure during the quarter. In short, much of the growth is still coming from consumer spending, especially on services, rather than on goods.
The chart captures the break-up of the 3.2% GDP growth in the third quarter. As we shall subsequently see, the terms of trade played a significant part in this GDP boost.
Chart Source: US Bureau of Economic Analysis (BEA)
• Trade was king. While increase in exports of goods and services was a key contributor to the GDP thrust in Q3, it was ably supported by a sharp fall in imports in the same period.
• As stated earlier, consumer spending on healthcare and other services was a key driver of GDP growth in the quarter, even as spending on physical goods were weak.
• Positive growth in business investments reflects the increase in capital allocated to equipment and intellectual property products; which is a positive signal.
• On the downside, construction and housing continues to be under pressure, possibly because the rate hikes have made homes a lot dearer.
One thing analysts would not have missed is that the US markets reacted negatively to the higher GDP number. There are two reasons for the same. Firstly, this is likely to reinforce the Fed belief that higher rates are conductive to growth rather than antithetical to growth. That is partially true since higher rates have curtailed inflation and boosted real GDP growth. But, this is also likely to give the US Fed confidence that a soft landing is not only possible but also very likely. This may induce the Fed to persist with its current hawkish stance, at least well into the first half of 2023.
If one looks back at the current rate trajectory, rates have moved up from the range of 0.00%-0.25% to the latest range of 4.25%-4.50%. This entire up-move has happened in the 9 months since March 2022. While the US Fed may have already implemented a lot of its hawkish plans, the latest GDP data plus the positive upgrade is likely to enthuse the Fed to effect at least 75 bps more of rate hikes, possibly in three tranches in 2023. Fed is likely to believe that the growth dividends of lower inflation would more than offset any concerns that the markets may currently have about a hard landing.
For the Indian economy and the Indian markets, there are likely to be 3 key takeaways from the US Q3 GDP data above.
• Firstly, the RBI is likely to go with the argument that lower inflation will still be growth accretive in the medium to long run. This is more with reference to the impact of lower inflation on boosting the real rate of GDP growth. After the latest data release by the US, it looks like the RBI may not relent before another 50 bps rate hike at the bare minimum. Of course, this is likely to happen in tranches in 2023.
• The RBI is also likely to be all the more convinced about the positive correlation between rates and growth. This has been a debatable topics but the trade-off in rate hikes has always been whether the destruction of nominal growth will be more than the gains in real growth from lower inflation. With the latest US experience also supporting the theory, the RBI is likely to look at higher rates as conducive to real GDP growth.
• Above all, the return of positive real growth in the US is likely to have larger spill over effects for the Indian economy in terms of export demand and also in terms of tech spending. Both have larger implications for the Indian economy. At least in terms of derived growth, the implications would surely be positive for India.
• What about the stock markets and likely flows. As the US economy improves, there is likely to be a gradually shift to risk-off sentiments among global investors. That is likely to benefit the EMs like India the most, considering their distinct advantage on the current growth front. That could be a positive takeaway for the Indian equity markets.