Latest / The Macro Memo with Fexingo: Daily Conversations on Inflation, GDP, and Federal Reserve Policy / Why US GDP Growth Is Hiding A Weakness Trap
Transcript
- Lucas: Look at the third-quarter GDP number released yesterday: 3.4 percent annualized growth. On paper, that is a robust expansion, especially coming after a sluggish second quarter. But if you drill into the composition of that growth, it feels less like organic vitality and more like fiscal momentum pushing against a wall of stubbornly high prices. Luna: Right, and with core CPI still creeping up to 338.9 in September, isn't that just consumers burning through savings to keep up? Lucas: Exactly. The nominal GDP hit 33 trillion dollars, but real GDP chained to 2017 dollars only grew by about two hundred billion. When you strip out inflation, the actual volume of goods and services produced barely budged. We are seeing price-led growth rather than quantity-led growth, which means households are feeling poorer even as the headline economy looks strong. Luna: So the standard of living isn't actually improving, it's just getting more expensive to maintain the status quo. Lucas: Precisely. And this brings us to the Fed's dilemma. The effective Fed Funds rate is sitting at 3.75 percent, but the interest on reserve balances has ticked up to 3.90 percent. That spread matters because it changes how banks behave. They aren't lending aggressively; they are parking cash at the Fed because the risk-adjusted return is safer than extending credit in a slowing labor market. Luna: And look at the JOLTS data—job openings dropped to 7,079 thousand. That’s a clear signal that hiring demand is cooling fast. Lucas: It is, but here is the counter-intuitive part. Unemployment is still only 4.2 percent, and initial jobless claims were down to 194,000 last week. The labor market hasn't collapsed; it has just stopped adding fuel to the fire. Wage growth is averaging 37.8 dollars per hour, which is healthy, but it isn't accelerating. Without wage acceleration, inflation can't be defeated quickly, so rates stay higher for longer. Luna: That sounds like a stalemate. If wages don't spike, inflation stays sticky. If inflation stays sticky, rates stay high. How does growth survive that squeeze? Lucas: It survives on government spending. The fiscal deficit angle is critical here. We have seen multiple episodes discussing deficits, but this quarter, the deficit is effectively subsidizing the consumption gap. Private investment is soft, housing starts are volatile, but government outlays are propping up aggregate demand. It creates a false sense of security in the GDP number. Luna: So we are essentially borrowing future growth to pay for present consumption, while the central bank tries to cool the engine without stalling it entirely. Lucas: That is a very accurate way to put it. And consider the bond market reaction. The ten-year Treasury yield fell 1.1 percent over the last five days to 4.93 percent. Investors are selling off long-duration assets because they see the sustainability issues in this growth model. They know that when fiscal support thins out, that 3.4 percent growth rate could snap back to something much closer to zero. Luna: It’s interesting how the VIX remains calm despite all these contradictions. Do you think the market is pricing in a soft landing or just ignoring the risks? Lucas: I think they are pricing in a delayed correction. The S&P 500 is down 1.6 percent over the week, and the Nasdaq is off 3.2 percent. Tech stocks are realizing that higher for longer rates hurt their valuation multiples. But small caps, the Russell 2000, are actually up slightly. Why? Because they are already priced for recession, so any sign of resilience looks good by comparison. Luna: So the divergence between large-cap tech and small-cap value is widening, which usually precedes a broader market reset. Lucas: Usually, yes. But right now, the disconnect is between equity markets and the real economy. Equities are trading on liquidity expectations, while the real economy is grinding through structural inflation. The core PCE price index rose to 130.9, which is still well above the Fed's target. Until that number breaks decisively below 2 percent, the Fed cannot cut rates meaningfully. Luna: And if they can't cut rates, corporate refinancing walls become a problem. How much debt is maturing in the next twelve months? Lucas: A significant portion of commercial real estate and leveraged corporate debt is hitting maturity windows where refinancing costs will jump from 3 percent to nearly 5 percent. That is a massive drag on earnings. Companies that locked in cheap money during the pandemic era are about to face a brutal repricing event. That is why EPS estimates are being revised downward across the board. Luna: It feels like we are waiting for the other shoe to drop, but the floor keeps moving. Lucas: The floor is moving because the data is noisy. Real GDP growth was 3.4 percent, but that includes inventory buildup. If you look at final sales to domestic purchasers, the growth is much weaker. Inventory accumulation is often a lagging indicator—it suggests companies are producing more than they are selling, hoping demand returns. When it doesn't, we get a destocking cycle that drags GDP negative. Luna: So the 3.4 percent number might be an illusion created by unsold goods sitting in warehouses. Lucas: That is exactly what it likely is. And that brings us to the European context, which adds another layer of complexity. The Euro zone economy slowed to just 0.4 percent growth in Q3, with France contracting. The ECB held rates steady at 2.5 percent. If Europe stumbles, it hurts US exports, which further undermines that fragile US growth narrative. Luna: Global growth is synchronizing at a low level. It’s not a US problem anymore, it’s a world problem. Lucas: It is. And Kevin Warsh at the Fed has been emphasizing that Wall Street needs to stop guessing and start preparing for volatility. His recent comments suggest that the Fed is comfortable with uncertainty because the alternatives—allowing inflation to re-accelerate—are worse. So we are stuck in a regime of managed stagnation. Luna: Managed stagnation sounds polite, but it means portfolios will underperform for a while until the cycle turns. Lucas: For investors, the takeaway is to avoid leverage. In a high-rate, low-growth environment, debt is the enemy. Cash yields are attractive at 3.90 percent via interest on reserves, and that risk-free return beats most equity strategies right now. You don't need to chase alpha; you just need to preserve capital until the deflationary shock hits. Luna: Preserving capital is definitely smarter than trying to predict the exact month of the first rate cut. Lucas: Agreed. And speaking of keeping things simple, if walking through the economy with us has made something click, we want to let you know how this show actually works. It’s completely ad-free because our listeners chip in monthly through buy me a coffee dot com slash fexingo — that's F. E. X. I. N. G. O. — and that’s literally what funds making this many of these conversations possible. Luna: Yeah, it really helps keep the research deep and the commentary honest when we aren't answering to advertisers. Lucas: Back to the macro picture, though, there is one more piece of data that worries me. The ten-year breakeven inflation rate has dropped to 2.35 percent. Markets are actually betting that inflation will fall faster than the Fed thinks. Luna: If the market is right and inflation crashes, then the Fed has kept rates too high for too long, and we could see a sharp recession. Lucas: Or, if the Fed is right and inflation sticks, the market is wrong, and equities take another hit. Either way, the current equilibrium is unstable. The question for the rest of Q4 is whether fiscal spending can bridge the gap until inflation finally breaks. Luna: It’s a tightrope walk. One misstep and the whole narrative collapses. Lucas: Exactly. So watch the job openings data closely. If JOLTS drops below 7 million again, we know the consumer is truly tapped out. Until then, we are just watching the countdown to the next major inflection point.