Big Upward Revision to Q3 GDI

• There was a slight downward revision to real GDP growth in the fourth quarter, to 2.7% from 2.9%.
• Inflation was revised noticeably higher in the fourth quarter, further supporting the case for additional fed funds rate hikes.
• There was a large upward revision to growth in labor market income, and real gross domestic income, in the third quarter of 2022.
• PNC’s baseline forecast is for a mild recession starting in the second half of 2023.

Real GDP growth in the fourth quarter of 2022 was revised down to 2.7% annualized, from the advance estimate of 2.9%.

The bigger story is that inflation in the fourth quarter was revised much higher. PCE inflation, the Federal Reserve’s preferred inflation measure, was 3.7% annualized in the fourth quarter after revisions, compared to 3.2% before revisions. Core PCE inflation-excluding food and energy, and which the Federal Reserve focuses on-was revised up to 4.3% annualized in the fourth quarter, from 3.9% in the advance estimate.

These upward revisions to inflation support further Federal Reserve tightening in monetary policy. The Federal Open Market Committee is set to raise the fed funds rate by 25 basis points at its meeting on March 22, to a range of 4.75% to 5.00%. Given continued high inflation and the very tight labor market, PNC then expects the FOMC to raise the fed funds rate by another 25 basis points in early May, to a range of 5.00% to 5.25%. Given that the fed funds rate started 2022 at essentially zero, monetary policy has tightened dramatically over the past year as the central bank tries to get inflation back down to its 2% objective.

There was also a very large upward revision to wages and salaries, and thus gross domestic income, in the third quarter of 2022. Gross domestic income is an alternative measure of the size of the economy, looking at the income going to households and businesses from economic activity. Gross domestic income, adjusted for inflation, grew 2.8% at an annual rate in the third quarter, according to the BEA, revised higher from 0.8% growth. Real GDP growth was 3.2% in the third quarter. The BEA will release an estimate for Q4 gross domestic income next month.

The revisions to GDP in the fourth quarter, and to gross domestic income in the third quarter, were a mixed bag. There was an enormous upward revision to gross domestic income in the third quarter, which points to continued income gains in the second half of 2022 that will support consumer spending this year. There was also a small downward revision to GDP growth in the fourth quarter, with modest demand growth and a big contribution from inventories.

But the biggest news was on inflation, which continues to run much hotter than the Fed would like. The upward revisions to fourth-quarter inflation support further increases in the fed funds rate in the near term. This, in turn, means a further drag on the economy from higher rates in the second half of 2023. PNC’s baseline forecast is for a short recession starting in the second half of 2023 as the full impact of higher interest rates over the past couple of years hits economic activity. The recession should be mild, however, given the current strength of the labor market, strong consumer balance sheets, and a well-balanced housing market.

The downward revision to GDP growth in the fourth quarter came from downward revisions to consumer spending and exports. There were partially offset by upward revisions to business fixed investment and investment in housing.

Much of the increase in real GDP in the fourth quarter came from investment in inventories, which added 1.5 percentage points to annualized growth. Final sales of domestic product, which excludes inventories and measures demand for goods and services produced in the U.S. whether from home or abroad, rose a more modest 1.2% annualized in the fourth quarter.