"Q4 2024 - The Consumer Stays Strong"

GROSS DOMESTIC PRODUCT

• Aggregate GDP grew at an annualized pace of 2.3% in Q4 2024, which is a slight deceleration from the prior quarter’s figure of 3.1% – however still represents an above-trend rate of growth. Over the past 12 months, GDP has averaged a quarterly growth rate of 2.5%, which is moderately above what many believe to be the long-term trend growth of the economy at 2.0%^1,2
  • Consumption
    • Consumer Spending, by far the largest part of the economy, grew at an accelerated pace in Q4, coming in at a level of 4.2%. Q4’s rate of Consumer Spending growth was the highest reading in the last 7 quarters – further signaling the strength of the consumer over this time. Robust growth was seen across both Goods and Services spending, with each growing at a rate of 6.6% and 3.1% respectively. Within the Goods category, Durable Goods surged by 12.1% which was led by strong growth in all sub-categories – particularly from Automobile spending which grew at a pace of 13.9%. Non-Durable Goods spending increased by 3.8% in Q4 and was bolstered by Clothing & Footwear growth of 7.5% and Other Non-Durable Goods growth of 5.2%. Within the Services category, there were a few notable sub-categories of interest, as all sub-categories experienced positive growth in the quarter. Healthcare spending came in at 4.1%, Transportation Services grew at a pace of 3.4%, Food Service & Accommodations grew by 2.5%, and Recreation Services grew by 2.0% in the quarter.  ^1,2
  • Investment
    • The Private Investment component of GDP contracted in Q4 by -5.6%, which was mainly due to stagnation in Inventory Spending – a sub-category that is primarily responsible for the majority of the Private Investment components volatility. Non-Residential Investment contracted at a pace of -2.2% in Q4, which was lead by a large drawdown in Equipment Spending of -7.8%. Within Equipment Spending, it appears that a large contraction in Transportation Equipment of -14.0% was the primary source. Additionally, Computer & Peripheral Equipment spending saw a large contraction in Q4 of -23.4%, which may have been a normalizing quarter for this item as the last 4 quarters of growth in this sub-category ranged from 20-39%. Residential Investment grew at a pace of 5.3% in Q4, which was bolstered by Structure spending growth of 5.3% and Equipment spending growth of 4.9%. Single-Family housing spending broke a 2 quarter contractionary streak coming in at a growth rate of 3.1%. Multi-Family housing spending contracted for the sixth consecutive quarter, coming in at a drop of -7.2%. Changes in Inventory levels for firms contributed negatively in the quarter having only added about 4.4B worth of provisions – a steep drop from the 58B added in Q3.^1,2
  • Net Exports
    • The U.S. Trade Deficit stagnated in Q4, coming in at a level of -$1.066T. For the first time since Q2 of 2023, both Exports and Imports contracted in the quarter. U.S. Exports dropped by -0.8%, while U.S. Imports also dropped by -0.8%. U.S. Exports of Goods declined by -5.0%, however exports of Services actually advanced by 7.2%. Regarding Imports, U.S. Imports of Goods dropped by -4.0%, and Imports of Services advanced at a pace of 12.8%. Important to note, recent developments in the international tariff backdrop have yet to come into effect as of the time of this writing^1,2
  • Government
    • The Government Spending component of GDP grew at a modest pace of about 2.5% in Q4. Federal Government spending grew at a pace of 3.2% – a drop from the 8.9% rate of growth in Q3. Within Federal Government spending, Defense spending grew at a pace of 3.3% and Non-Defense spending grew at a pace of 3.1%. State & Local Government spending grew at a pace of 2.0% in Q4. State & Local Government Consumption Expenditures, as well as Gross Investment, both grew in Q4 by about 2.0%^1,2

 

EMPLOYMENT

• The Unemployment Rate for the U.S. Economy ticked upward in September and now stands at a level of 4.0%, up from the recent low mark of 3.7% in December 2023. Upticks in the Unemployment Rate have been mostly driven by a lower rate of growth in the Labor Force relative to growth in Unemployed Persons^1,3

• Regarding the Labor Force, we have seen a steady increase in the metric over the past few years and are now at an all-time high level of 170.7M^1,3
  • Higher levels of wage growth are an important factor driving growth in the Labor Force over the past year^1,3
  • The Labor Force Participation Rate remains below pre-pandemic levels and is now at 62.6%. Pre-Pandemic levels were roughly closer to 63%^1,3

• Within the Household Survey, the number of Employed Individuals has increased materially over the past month after stagnating from the start of 2023. The number of Employed Individuals rose to a level of 163.9M after previously being rangebound around the 161M level^1,3

• A key metric monitored by the Federal Reserve, Job Openings, have moderated significantly over the past 2 years, which is largely seen as a positive sign from the Fed that the Labor Market is back in better balance. Job Openings are down to 7.6M from the all-time high mark of 12.18M achieved in 2022^1,3
  • There are now 1.11 Job Openings available for every unemployed person^1,3
  • The number of Unemployed Persons currently stands at a level of 6.8M, an uptick from 6.1M seen at the start of the year^1,3
  • Moderation in the number of Job Openings has been a key factor referenced by the Federal Reserve as a potential sign to begin Monetary Policy normalization via ceasing Rate Hikes, and potentially beginning a Rate Cut Cycle^1,3
  • Regarding the Labor Market’s effect on overall Inflationary Pressures, the Fed now officially no longer sees an abnormally unbalanced Labor Market as being a contributor to inflationary pressures ^1,3
    • (Federal Reserve) “With regard to the outlook for the labor market, participants noted that further cooling did not appear to be needed to help bring inflation back to 2 percent”^1,3

• Average Weekly Earnings are up 3.3% over the past year^,3
  • Over the past year, Average Weekly Earnings increases have been entirely attributed to increases in Wage Growth as opposed to Hours Worked^1,3
  • Elevated Wage Growth, in tandem with consumer substitution effects, have been instrumental factors in allowing U.S. consumers to partially offset the effects of higher Inflation^1,3

 

INFLATION

• Headline PCE Inflation came in at an annualized pace of 3.1% in December which was the highest reading since April 2024’s reading of 3.2%. During Q4 Headline PCE Inflation averaged a pace of 2.5%, markedly lower than the December figure. Headline Inflation averaged a pace of 2.6% for calendar year 2024^1,4
  • Core PCE Inflation came in drastically lower than Headline Inflation in December with a reading of just 1.9%. Core Inflation also averaged a lower rate in Q4 coming in at just 2.2%. Core Inflation for calendar year 2024 averaged 2.8%, which was largely driven by higher-than-expected readings in Q1 – recent data has been more normalized^1,4
  • Notable disinflationary pressures have been present in the economy relative to Q1 2024 when hotter-than-expected inflation readings surprised the economy and lead to Fed to delay the start of the Rate Cut Cycle^1,4

 

• Material differences continue to persist between Goods Inflation and Services Inflation^1,4
  • Goods prices have averaged a rate of deflation of -0.6% from the period of Q2 through Q4, with 6 of those 9 months experiencing deflationary pressures ^1,4
    • Durable Goods have also averaged a rate of deflation of -1.6% during the Q2 through Q4 period, with December’s reading of -4.9% being the largest contractionary month for the metric since May 2024^,4
    • Non-Durable goods have experienced a moderate degree of volatility over the year with regards to inflation. Non-Durable goods saw inflation come in at 6.0% in December, while also averaging just 1.6% during Q4. For the calendar year 2024, Non-Durable goods averaged inflationary readings of just 0.60%. Significant volatility in Energy prices contributed materially to the outsized December reading ^1,4
  • Services Inflation has largely been the area of the economy exhibiting the more robust and persistent inflationary pressures over the past year. Over the past 12 months, Services Inflation has averaged a level of 3.6%, compared to a level of 5.6% during Q1 2024. Q4’s average reading came in at 3.4% ^1,4
    • Within the Services category, there are a few sub-categories that standout as being noteworthy. Transportation Services have been erratic over the past year, averaging an inflation rate of 10.1% over the past three months, mostly due to significant cost increases in Public Transportation items. Healthcare Services experienced average inflationary pressures in calendar year 2024 of 2.5%. Natural Gas prices have seen a robust 4 month stretch of abnormally high inflationary pressures, averaging a rate of 14.7% over that period. Rent prices have experienced steady/elevated inflationary pressures over the past 12 months – averaging an abnormally high pace of 4.3% over this time, although Q4’s average Rent Inflation reading was just 3.3%^1,4

 

• Market Expectations of future inflation levels have been extremely stable since the mid-point of 2022, a potentially welcome sign for the economy as expectations of future inflation have historically been closely correlated with actual inflation to come^5,6
  • Market Expectations for future Inflation on a 5yr forward looking basis have been rangebound between 2.0% and 2.5% since 2022. Q4 did see an uptick in the market’s expectations of 5yr inflation, rising from the 2.0% all the way to 2.5%^5,6
  • Market Expectations for future Inflation on a 10yr forward looking basis have also been rangebound between 2.0% and 2.5% since 2022. The same upward trend in forward looking expectations exhibited in Q4 for 5yr inflation was also mirrored in the 10yr inflation metric^5,6

 

FORWARD LOOKING ASSESSMENT

One of the hallmark discussions over the past few years has been the preponderance of whether or not it was even possible for the Federal Reserve to tighten its monetary policy stance to combat inflation without eventually careening the labor market (and by transitive property the whole economy) into a tailspin. Granted, lower pricing pressure is a benefit to practically everyone in some way shape or form, however if achieving that end goal meant incurring “more damage than the medicine can heal” then perhaps there could not have been an easy way out of the recent inflationary woes without some pain. What to do?

The general idea here is that higher interest rates would tighten financial conditions by making loans less affordable to take on, and thereby businesses and consumers who require debt financing for various things (equipment, cars, houses, etc.) would scale back their purchasing – a drop in demand. This corresponding drop in demand was theoretically the “medicine” the economy needed to cure itself of the pains of abnormal inflation, but significant uncertainty remained over whether or not the ensuing effects of tighter monetary policy were going to either be a “little drop” in demand, or rather a “canoe ride into the depths of hell” for demand. Turns out, as it usually does, the truth was somewhere in the middle.

Yes… interest rates did rise by a historical amount (historically quickly as well) – and yes… this did tighten financial conditions; however, this is some nuance to the data which I think does a great job of explaining why we haven’t exactly taken that canoe ride just yet.

When the Fed first started hiking interest rates in mid-2022 consumer credit levels were not only expanding (as they usually do in normal time – that’s not worrying) but they were expanding at a rate that was far higher than what the Fed deemed reasonable to achieve stable prices. Remember, excess accumulation of debt is how bubbles start. As a frame of reference, consumer debt was expanding at a pace of about 7% on average during the pre-hike runup. Since then, a much more “mature” approach has appeared to have been adopted – averaging about 2-3% since the hike cycle started.

It’s a long way of saying and quantifying what we were told from the start in that hiking rates would cool the economy, but it was cooling an economy that was too hot back to room temperature… not all the way down to absolute zero. There is, however, another major reason why the economy has been so resilient during the past few years and it is the concept that consumers remain gainfully employed and financially in a position to spend. It’s fairly difficult to envision a situation where the economy plunders into a recession when everyone is still working and making money. No mass job loss pretty much means no “real deal” recession.

Now you might say something along the lines of “Well, the unemployment rate is higher now than it was at the start of the hike cycle – so job loss occurred”. Very true, however, given the generally accepted assessment that the labor market was imbalance and operating a level moderately above maximum employment levels before the hike cycle, we can most likely conclude that this was not a structurally detrimental uptick in the unemployment rate, but rather a “coming back to normal” type of move. Additionally, given the idea that the unemployment rate has been stable for about a half of year now, this is more evidence to that notion.

As we sit here today, very much still in what the Fed would call “restrictive financial conditions” it’s natural to ask where will we go from here. Well, strangely enough, we may not actually ‘need’ to be in a materially different spot with regards to financial conditions, and as such, we may just kind of ‘hang-out’ in our current state for a bit. That’s right, higher interest rates (savers rejoice), a maximum employment labor market, solid wage growth, slightly higher than normal inflation, and strong economic growth. Taking a step back, this is a picture that doesn’t exactly scream ‘fix immediately’ and I think the Fed may feel the same way. The market seems to also think the Fed feels this way, as it has priced-in the probability of pretty much no major rate cuts (or hikes) for the next few quarters.

This essentially equates to a general consensus of “same place, different time” type of mindset. So, until next time, don’t be alarmed if things look very similar when we talk next.

[See Below for Disclosures & Annotations]

DISCLOSURES

Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

The companies presented here are for illustrative purposes only and are not to be viewed as an investment recommendation.

Tax laws and regulations are complex and subject to change, which can materially impact investment results. LPL Financial does not provide tax advice. Clients should consult with their personal tax advisors regarding the tax consequences of investing.

 

ANNOTATIONS

1. FactSet. “Economics – Country/Region – United States”. January 31, 2025
2. Bureau of Economic Analysis. “Gross Domestic Product, 2nd Quarter and Year 2024 (Advance Estimate)”. January 31, 2025.
3. Bureau of Economic Analysis. “Labor Force Statistics from the Current Population Survey”. August 1, 2024.
4. Bureau of Economic Analysis. “Personal Income”. January 31, 2025.
5. FRED. “5-Year Breakeven Inflation Rate”. January 31, 2025.
6. FRED. “10-Year Breakeven Inflation Rate”. January 31, 2025.