US economy: Ending 2023 on an unexpected high

by Nikhil Mohan, Economist, Franklin Fixed Income, Franklin Templeton

US gross domestic product surprised to the upside in the fourth quarter of 2023, primarily led by US consumers and the government. Franklin Fixed Income Economist Nikhil Mohan sees the growth mix remaining largely the same in 2024.

US gross domestic product (GDP) surprised to the upside in the fourth quarter of 2023, growing 3.3% on a quarterly annualized basis—well above our expectations (2.1%) as well as consensus expectations (2.0%).¹ Some of the upside surprise was likely due to the lower-than-anticipated price deflator growth (1.5% actual vs. 2.2% expected) and the positive contribution from net exports.² However, it was the consumer and government consumption that continued to do much of the heavy lifting, with the two alone contributing 2.6 percentage points (pp) to headline GDP. Growth and contributions from both residential and non-residential investment remained muted.

We expect the growth mix to remain broadly similar going forward, with the consumer and the government (especially given it’s an election year) likely to power growth in 2024 as well. While inflation has slowed notably (the Core Personal Consumption Expenditure [PCE] deflator is already at 2% on a quarterly annualized basis), the labor market and wages haven’t softened quite as swiftly.³ Therefore, real incomes should remain supportive of household consumption. Likewise, the positive wealth effect from the increase in valuations for real estate and equities over the past 2-3 quarters should also be a net positive for consumption. Moreover, as inflation has receded, consumer sentiment has risen, as indicated by both the University of Michigan and Conference Board surveys. We believe that positive outlook from households should keep the economy on track for further expansion, even if other drivers of growth remain lackluster.

Although business investment slowed markedly on a sequential basis in the second half of 2023, it still ended up 4.1% higher on a year-over-year (y/y) basis, which puts it right in line with the 2015-2019 average, and this is despite a significantly higher interest-rate environment. However, looking ahead, business investment may remain muted given the uncertainty ahead of elections in November, along with rising concerns about weaker global growth.

As for residential investment—there already appear to be some green shoots in the form of rising new home sales, building permits and housing starts, while existing home sales have turned less negative (all on a y/y basis). Moreover, with mortgage rates down over a 100 basis points since late October, mortgage applications have started to turn up again (albeit from very low levels). While lower borrowing costs should support residential investment (particularly in the second half of 2024), a tight housing market has meant that existing home prices have continued rising through much of 2023—up over 4% y/y.⁴ However, new home prices have bucked this trend as homebuilders tried to offset the high rates environment by actively lowering prices through 2023—down almost 14% y/y—which in turn aided sales.⁵ However, new homes account for roughly 14%-15% of total home sales.⁶ Therefore, the lack of affordable housing will likely continue to offset some of the positives even as borrowing costs edge lower.

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1. Sources: Bureau of Economic Analysis, Franklin Fixed Income, Bloomberg. As of January 25, 2024.

2. Sources: Bureau of Economic Analysis, Franklin Fixed Income, Bloomberg. As of January 25, 2024.

3. Source: Bureau of Economic Analysis. As of January 25, 2024.

4. Source: S&P CoreLogic Case-Shiller Home Price Index. As of January 25, 2024.

5. Source: US Census. As of January 25, 2024.

6. Source: US Census. As of January 25, 2024.