Mixed Signals: U.S. economy showing signs of strain even as activity appears brisk

Three commonly cited nowcasts for GDP growth rates include those produced by the Federal Reserve Banks of Atlanta, New York, and St. Louis. Atlanta’s is possibly the best known and in recent years has tracked the actual GDP numbers quite closely. Even so, the final nowcast for the quarter can differ by 1 to 2 percentage points. New York’s nowcast generally fluctuates less than actual GDP and was less accurate in the first two quarters of this year when GDP saw extreme fluctuations from import activity. St. Louis’s nowcast has underestimated actual GDP growth in most quarters in the past three years with a notable exception in the first quarter this year when higher imports pushed GDP lower.

As of November 19, these three nowcasts were 4.2% (Atlanta), 2.3% (NY), and 0.6% (St. Louis). While that is a fairly large spread, when we look at the recent behavior of all three of these estimates, something between the Atlanta and New York estimates seems reasonable. The average of all three is 2.4%. The Blue Chip consensus (a survey of professional forecasters) had been moving up towards 3% as the quarter ended.

The source of the additional growth predicted by the 4.2% Atlanta nowcast is mainly from increased consumption spending. The evidence they cite for this is the strong disposable personal income (DPI) from August. Unfortunately, the August number was the last DPI released before the government shutdown. September and October’s DPI is not yet available. If the weakening labor market is starting to affect DPI, that could take a few tenths of a percent off the GDP growth rate.

Investment in structures is expected to subtract 0.27% from GDP growth while change in private inventories is expected to add 0.35%. Change in private inventories have been more volatile this year because of tariffs. If firms have been drawing down inventories more than expected this quarter, it could subtract as much as a point or two from GDP growth. More than a point or two difference seems unlikely, but it would not be out of the question to see some more drawdown during the later part of the quarter than would have been expected early in the quarter. That could drop the number down to something closer to 3%.

If GDP growth comes in closer to 3%, it would be a slowdown from the 3.8% in the second quarter, but still a very respectable showing.

Inflation remains above the Fed's 2% target. For the 12 months ending in September, inflation measured by the Consumer Price Index (CPI) was 3.0%, up from the 2.9% the month before. The Fed's preferred inflation gauge, the Personal Consumption Expenditures (PCE) price index stood at 2.7% for the 12 months ending in August and 2.9% for the same period after excluding food and energy. These were the highest levels for the PCE since February of this year.

Tariffs are at least partly to blame for the higher prices, though the main effects have been seen only in a small subset of goods. The Yale Budget Lab has been producing analyses on the effects of tariffs this year. Their most recent update from November 17 estimates that there has been about a 1.3% increase in the overall price level in 2025 due to tariffs. Clothing and leather have been most affected with an estimated 20% increase in the price of leather products. Tariffs on metal imports have also caused certain consumer products to have a 17-18% short-run price impact. However, the long-run price impact is expected to be only 5-6% after substitution effects. This means we could see some relief in prices in those products containing metals in the coming year. Motor vehicle prices are expected to rise similarly with a 13% price increase in the short-run and 5% in the long-run.

The Yale Budget Lab also expects that long-run output in the manufacturing sector will expand by about 3% while construction and agriculture will contract by 4% and 1%, respectively. Overall, they see a slight contraction in overall activity due to tariffs, on the order of a 0.3% long-run loss of GDP.

This is all under the assumption that there will be significant reshoring activity in manufacturing. As of now, we are still in the short-run phase of the adjustment process with tariff levels still subject to negotiation with our trading partners and adjudication in the courts. Businesses are still adjusting to the tariffs, which is one of the most important factors putting stress on the economy. This is particularly evident in manufacturing intensive areas of the country such as the Quad Cities. We discuss this in more detail in relation to our Business Outlook Survey elsewhere in this report.

Perhaps the most quoted line from Federal Reserve Chair Jerome Powell’s remarks after the October meeting were that, “A further reduction in the policy rate at the December meeting is not a foregone conclusion—far from it. Policy is not on a preset course.” In the end, the committee voted to lower the policy rate by 0.25%, however there were two dissenting votes: one voting to lower the rate by 0.50% and one voting to keep the rate unchanged. It is unusual to have dissent in both directions from the consensus. On the one hand, it suggests that the majority of the committee is clearly on the “middle road.” However, it also highlights the fact that the mixed signals being given by the economy are leading to different interpretations of where we are headed, and thus what the direction of policy should be.

At the heart of the disagreement is the question of whether the current inflationary pressure is due to the short-run effects of tariffs and therefore likely to subside next year. If you believe that the tariff effects are likely to subside (as discussed above), then you could make the case for another rate cut in December (as Governor Waller did in his speech noted earlier). Evidence for this view is the fact that wage pressure does not seem to be especially strong as the labor market weakness is mostly due to lower demand in this “no hire/no fire” labor market. Adherents to this view would argue that another rate cut to prevent additional labor market weakness would be appropriate. As of November 20, the market expectations are that there is only about a 40% probability of a rate cut in December according to CME Fed Watch. This suggests that the dominant view is that inflation, tariff-induced or not, is still a more worrisome problem because the labor market, for all its signs of weakness, is still hanging in there with low unemployment even as job growth slows.

As in the second quarter, the Midwest experienced little change in economic growth in the third quarter. The State Coincident Index from the Philadelphia Fed increased by 0.5% for Illinois (compared to 0.7% in the second quarter) and increased by less than 0.1% for Iowa (compared to a 0.6% decrease in the second quarter). Because these indexes rely heavily on government statistics affected by the shutdown, data was only available through August.

Additional details related to the Quad Cities labor market are covered elsewhere in this Quarterly Market Report.

The Federal Reserve's Beige Book, which reports on economic conditions in the 12 Federal Reserve districts across the country, noted the following about conditions in the Chicago district (where the Quad Cities is located) in October: "Economic activity in the Seventh District was flat. Consumer spending increased modestly; construction and real estate activity increased slightly; employment was flat; nonbusiness contacts saw no change in activity; business spending declined slightly; and manufacturing activity declined modestly. Prices rose moderately, wages were up modestly, and financial conditions loosened slightly. Prospects for 2025 farm income were unchanged."

The note about construction and real estate activity increasing slightly is borne out in the statistics on housing prices, which is one bright spot when comparing the Midwest (including the Quad Cities) to the rest of the country. The housing market here is not as hot as it was earlier in the cycle in the rest of the country. However, it is holding its own while other regions are starting to see weaker housing activity.

The Weekly State-Level Economic Conditions Index was slightly lower than the U.S. index for most of the quarter until the very end when the indexes for both Illinois and Iowa turned higher while the U.S. index turned lower.

Source: Christiane Baumeister & Danilo Leiva-León & Eric Sims, 2024. "Tracking Weekly State-Level Economic Conditions," The Review of Economics and Statistics, MIT Press, vol. 106(2), pages 483-504, March.

Mixed signals are often a sign of increased vulnerability. Consumer spending has supported the economy for some time now. If spending were to drop due to an oil price shock or job losses, economic growth would suffer. The volatility caused by tariffs have caused businesses to alter their decisions, adding to the stress on the market. The fourth quarter is also likely to take a hit from the government shutdown which will likely shave at least a few tenths of a percent off of GDP growth.

For the Quad Cities economy, there are some concerns along with some bright spots. The Midwest economy is flat and appeared to be slowing for most of the quarter. Manufacturing has felt the negative effects of tariffs. Job growth in the Quad Cities is down from last year at this time. However, respondents to our Business Outlook Survey note more optimism about their own businesses than they do about the overall U.S. economy. There is at least some evidence that the Iowa and Illinois economies started to turn in the positive direction at the end of the quarter. Also, while significant reshoring of manufacturing is still months or years away, there is reason for cautious optimism.

While there is no reason yet to expect any significant decline in activity leading to a recession, there are risks. The economy has endured more volatility than usual this year. Markets are stressed, and concerns about job losses are elevated. With conditions likely to improve once we are fully adjusted to the new tariff levels, we still have a few months of increased vulnerability to unforeseen shocks.