Fed vindicated as growth gathers momentum in US with 3.5 per cent rise

The increase was driven by government spending – especially on defence – personal consumption and exports

The US economy grew at a better than expected rate of 3.5 per cent in the third quarter, supporting the Federal Reserve’s assertion of “sufficient underlying strength” when it felt confident enough to end its stimulus measures this week.

Some investors worried that the growth rate could lead to an earlier interest rate rise by the Fed, but the Dow Jones index rose more than 1 per cent yesterday, passing the 17,000 mark again.

The 3.5 per cent annual rate of increase in GDP – much better than the 3 per cent economists had expected – followed a rise of 4.6 per cent in the second quarter for the strongest back-to-back GDP statistics since the second half of 2003.

The increase was driven by government spending – especially on defence – personal consumption and exports. “The [economic] report was broadly constructive, with the gains broadly based and pointing to positive underlying momentum,” said Millan Mulraine, deputy chief economist at TD Securities in New York.

Data on jobs has also helped optimism. The official unemployment rate fell to 5.9 per cent last month, the lowest for about six years.

And yesterday there were further signs that the jobs market is strengthening. The number of Americans filing new claims for unemployment benefits rose for a second successive week, but stayed at levels considered consistent with a firming market.

Initial claims for state unemployment rose 3,000 to a seasonally adjusted 287,000 in the week to 25 October.

However, the four-week moving average of claims, considered a more accurate measure because it smooths out weekly spikes, fell 250 to 281,000.

These statistics also supported the Fed’s statement on Wednesday when it brought its third round of “quantitative easing” – buying Treasury and mortgage-related bonds to boost the economy and force interest rates lower – to an end.

“Labour market conditions improved somewhat further, with solid job gains and a lower unemployment rate,” said the Fed. “On balance, a range of labour market indicators suggests that under-utilisation of labour resources is gradually diminishing.”

The July-September period was the fourth quarter out of five in which the American economy has grown by 3.5 per cent or more.

Many traders have been calmed by the Fed’s promise to continue reinvesting payments from maturing bonds in new debt securities, which should help to keep interest rates low for some time. However, this week’s positive news has led some traders to believe that the end of the cheap money era really is nigh.

“A strong report, on the heels of a more hawkish tone from the Fed yesterday, has some investors thinking we could see a rake hike faster than might otherwise have been hoped,” said Bruce McCain, chief investment strategist at Key Private Bank in Cleveland.

He added: “That’s dampening the spirits of investors who were hoping for easier monetary conditions for an extended period.”