U.S. economy grows with 4.3% GDP gain

U.S. Economic Outlook: Q3 Growth, AI Capex, and 2026 Projections

Key Concepts:

• AI Capex Cycle: Increased capital expenditure driven by investments in Artificial Intelligence technologies.
• Productivity Growth: The rate at which the economy produces goods and services per unit of input (labor, capital).
• K-Shaped Economy: A scenario where economic recovery is uneven, benefiting high-income earners while leaving lower-income earners behind.
• High-Frequency Credit Card Data: Real-time data on consumer spending patterns derived from credit card transactions.
• Services Disinflation: A decrease in the rate of price increases for services.
• Federal Reserve (Fed) Policy: Actions undertaken by the Federal Reserve to manipulate the money supply and credit conditions to stimulate or restrain economic activity, primarily through adjusting interest rates.

I. Q3 2023 Economic Performance & Drivers

The U.S. economy experienced robust growth in the third quarter of 2023, registering a 4.3% quarter-on-quarter increase (July-September). This represents the fastest growth rate in two years. Despite weakening consumer sentiment and a slowing labor market, the primary driver of this growth was a resilient U.S. consumer, coupled with significant productivity gains. Specifically, productivity growth is tracking at 5% for Q3, building on already strong performance in Q2. This suggests a fundamental shift in economic dynamics, potentially influencing the Federal Reserve’s projections for 2026.

II. The Role of AI Capital Expenditure (Capex)

Artificial Intelligence (AI) investment contributed 0.5 percentage points to the Q3 GDP growth. While this appears substantial, the overall impact on GDP is less pronounced than initial figures suggest. However, AI Capex is a significant driver of investment and is expected to remain a key growth story, although its impact is projected to be less potent in 2025. The focus is on the investment component, rather than a massive overall GDP impact.

III. Q4 2023 & Q1 2024: Headwinds and Rebound

A slowdown is anticipated in the fourth quarter of 2023. Two primary factors contribute to this expectation: the government shutdown (estimated to subtract 0.7 percentage points from Q4 GDP) and a deceleration in consumer spending. High-frequency credit card data indicates consumers are reducing their spending pace. However, the impact of the government shutdown is expected to be temporary, with a payback effect anticipated in Q1 2024.

IV. Consumer Spending Dynamics & Tariff Impacts

Consumer spending has remained strong, but a nuanced picture emerges. While overall spending is holding up, it’s largely driven by upper-income consumers, particularly on services – a characteristic of a “K-shaped” economic recovery. Tariffs have had a limited impact, with U.S. retailers largely absorbing the costs. Some pass-through to consumers is evident in goods inflation, particularly for items heavily reliant on trade with China (e.g., toys). However, the price increases haven’t been as significant as initially anticipated.

V. Inflation Outlook for 2024-2026

Inflation is expected to rise to between 3% and 3.1% in the near term (Q4 2023 – first half of 2024) due to pass-through effects. However, as the tariff story fades and services disinflation takes hold – particularly in the housing segment with declining rents – overall inflation is projected to fall to around 2.5% by the end of 2026. The key driver of disinflation in the second half of 2026 will be the cooling housing market.

VI. Federal Reserve Policy & Interest Rate Cuts

TD Securities anticipates three 25-basis-point interest rate cuts from the Federal Reserve in 2024, occurring in March, June, and September. However, the March cut is uncertain, contingent on economic data. January is considered a likely pause point for the Fed. The Fed’s decisions will be heavily influenced by the labor market. If the unemployment rate stabilizes around 4.5%-4.6%, the cuts are more likely to proceed as planned.

VII. Labor Market Considerations & 2026 Growth Projections

The labor market remains a critical uncertainty. Continued momentum loss and a rising unemployment rate pose a risk to the economic outlook. The key question is whether the unemployment rate will stabilize or continue to climb. If it rises further, it will significantly impact the U.S. economy in 2026. Despite these concerns, the overall outlook for 2026 is positive, with the economy expected to expand close to its potential growth rate of around 2%.

Notable Quotes:

• “You have to buy the story that productivity is here to stay.” – Oscar Munoz, Chief U.S. Macro Strategist at TD Securities, emphasizing the importance of productivity growth as a key economic driver.
• “The consumer is not an aggregate consumer story. I think it's very bifurcated.” – Oscar Munoz, highlighting the uneven nature of consumer spending, with upper-income earners driving the majority of growth.

Data & Statistics:

• Q3 2023 GDP Growth: 4.3% quarter-on-quarter.
• Q3 2023 Productivity Growth: 5%.
• AI Investment Contribution to Q3 GDP Growth: 0.5 percentage points.
• Projected Impact of Government Shutdown on Q4 GDP: -0.7 percentage points.
• Projected Inflation (Q4 2023 – H1 2024): 3% - 3.1%.
• Projected Inflation (End of 2026): 2.5%.
• Projected Fed Rate Cuts (2024): Three 25-basis-point cuts (March, June, September – subject to conditions).

Synthesis/Conclusion:

The U.S. economy demonstrated surprising strength in Q3 2023, driven by robust productivity growth and resilient consumer spending, aided by AI Capex. While a slowdown is expected in Q4 due to the government shutdown and moderating consumer activity, the outlook for 2026 remains positive, with projected growth near potential. The labor market’s trajectory and the pace of services disinflation are the key factors that will determine the success of this outlook. The Federal Reserve is expected to implement measured interest rate cuts, contingent on economic data and labor market conditions.