Recovery remains resilient

Indicators of real economic activity for the U.S. have held up surprisingly well given the lack of confidence signaled through surveys and financial markets, according to Tyler Atkinson, research assistant in the Research Department of the Federal Reserve Bank of Dallas. Real gross domestic product (GDP) grew at an annualized pace of 2.5 percent in third quarter 2011. Inflationary pressures were subdued and show signs of converging to 2 percent.

Consumers rattled but keep opening their wallets
After the financial turbulence in August, many expected slower, or even negative, growth in the third quarter. Surveys of consumer confidence reflected this pessimism, falling to levels not seen outside of recession. Since then, “hard”—not survey-based—indicators of real economic activity have generally surprised on the upside. Retail sales have held up remarkably well, rising 1.1 percent in September. Real personal consumption expenditures (PCE) grew 0.6 percent in September and contributed 1.7 percent annualized to real GDP growth in the third quarter. This was a welcome development, although doubts remain about consumers’ ability to fuel recovery-like growth.

Output growth improved
Real GDP grew at a 2.5 percent annualized rate in the third quarter after a sluggish 0.8 in the first half of the year, putting to rest fears of impending recession. The improvement was broad based, with every major category besides inventory investment contributing more to growth than its first half average. Business investment was very strong, mostly in equipment and software. Behind PCE, nonresidential fixed investment contributed the second most to growth, 1.5 percentage points. Businesses still have plenty of cash to invest, but to continue investing at this rate they would likely need to expect stronger demand elsewhere. Real government consumption and investment did not change, after three consecutive quarters of being a drag on growth. Net exports were a small positive and remain a possible sustainable driver of recovery. However, slower growth in Europe should continue to dampen export growth.

Housing still bouncing along the bottom
Residential investment has traditionally led economic growth and has been a substantial driver of past recoveries. This recovery has had to do without a boost from residential investment, as home building stopped falling in 2009 and has moved sideways ever since. Housing starts increased to 658,000 in September, driven by a 51 percent increase in multifamily starts. The rent-of-primary-residency component of PCE inflation has ticked up to 2.1 percent over the past 12 months ending in September, indicating tightening in the rental market. With construction languished at historic lows for several years, any substantial increase in employment could spur household formation and some contribution from residential investment, even if it is from new apartments rather than single-family homes.

Employment still growing
Nonfarm payroll employment increased by 103,000 in September, and August and July were revised up to 57,000 and 127,000, from 0 and 85,000. This eased fears of a potentially contracting labor market. These numbers were distorted by 45,000 Verizon Communication Inc. workers on strike. In absence of the strike, August would have been stronger and September weaker. This brought employment growth in the third quarter to 0.7 percent, half the second quarter rate and below what is necessary to bring down the jobless rate. The household survey showed employment increasing by 398,000 in September, offset by the labor force increasing by 423,000, leaving the unemployment rate at 9.1 percent. Initial claims for unemployment insurance in October hovered near 400,000, consistent with a flat unemployment rate.

Inflationary pressures soften
The headline PCE price index increased by 2.0 percent annualized in September, down from 3.2 percent in August. This was unusual in that the sharp change was not driven by food or energy. The core PCE price index, excluding food and energy, decreased by 0.03 percent annualized, down from an increase of 2.04 percent in August. The fraction of components in the PCE basket experiencing price declines jumped to 43 percent, a level comparable to 2010 when inflationary pressures were consistently softening. The core 12-month rate of inflation fell to 1.65 percent from 1.68 percent, and the headline rate rose to 2.95 from 2.89. The core price decrease is surprising, but one month is not a trend. The smoother trimmed mean PCE rate, which excludes the largest price increases and decreases, was at 1.6 percent annualized in September and 2.1 percent annualized over six months. This is in line with expectations for inflation to converge to around 2 percent as energy price increases from earlier in the year pass through the system.