3Q 2021 GDP Growth Slows More Than Expected, Yield Curves Flatten

The third-quarter gross domestic product expanded at a meager 2% annualized rate following a 6.7% pace in the second quarter. Downwardly revised forecasts called for growth no slower than 2.6%, down from estimates of over 5% merely two months ago. The deceleration reflected a sharp slowdown in personal consumption, which grew at just a 1.6% pace after a rapid 12% jump in the prior quarter.  While supply chain challenges are expected to linger well into 2022, subsiding virus infections and elevated savings should support stronger household spending in the final three months of the year. Preliminary 4Q 2021 forecasts call for GDP growth of 5%.

During the week, U.S. stocks set more all-time highs as corporate earnings helped boost sentiment amid lingering concerns about inflation and economic growth.   Earnings season is helping to counter concerns that elevated inflation and tightening monetary policy will slow the recovery from the pandemic.  Some 81% of S&P 500 members have reported better-than-expected results so far this quarter.

Treasury yields continue to gyrate and flatten, with some portions of the yield curve inverting. Short-maturity Treasuries extended their selloff, pricing in higher odds that the Federal Reserve will address elevated inflation expectations at the bank’s meeting next week. Yields on Treasuries maturing in two to five years approached their highest levels of the past year, further narrowing the gap between short- and long-term rates. Flattening has been most prominent in the five-year sector, the portion of the yield curve that is not coincidently most sensitive to forecasted Fed rate hikes.

The Treasury yield curve inverted between 20 and 30 years this week, the first time this has ever occurred since the U.S. government reintroduced the 20-year maturity in 2020:

The Fed's favorite inflation indicator, the personal consumption expenditure (“PCE”) index, remains near 30-year highs. The headline PCE deflator rose 4.4% YoY, above August's increase of 4.2%. The core PCE deflator, that excludes food and energy process, rose 3.6% YoY, the same as August. Both are well above the Federal Reserve’s targeted average inflation level of 2.5%:

Although these PCE indicators are at their highest levels since 1991, Federal Reserve officials remain steadfast in their portrayal of current inflation as being temporary, poised to calm when global supply constraints ease and catch up with demand.

Home sales surge but reveal strong headwinds

Purchases of new single-family homes increased 14% to an 800,000 annualized pace after a downwardly revised 702,000 rate in August.  The figures suggest demand is stabilizing after high prices and a lack of inventory pushed the pace of contract signings below pre-pandemic levels in recent months. However, headwinds remain as ongoing supply chain and labor challenges slow construction and rising mortgage rates weigh on homebuyer affordability.

Pending home sales fell 2.3% in September after surging an unexpected 8.1% in August, This report is the third monthly drop in the last four months and leaves pending home sales down over 7% YoY. Pending sales are a forward-looking indicator of closed sales in the next one to two months. This decline suggests there may be trouble ahead for the rebounding sentiment among homebuilders.

Democrats still a house divided over social spending, tax increases

President Joseph Biden is laying out a framework for House Democrats for a $1.75 trillion tax and spending package that his administration believes will pass Congress - a potential breakthrough that still hinges on support from key moderates and progressives.  To pay for this spending, the package includes a minimum tax on corporations, a tax on stock buybacks, and new taxes on incomes above $10 million annually, with total revenue of an estimated $2 trillion over a decade, according to a White House fact sheet.  It’s unclear how far-reaching the agreement will be and whether enough Democrat lawmakers will sign on.