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Fed has no more excuses, after third-quarter GDP shows best growth in 2 years

An employee inspects the body of a Subaru Outback, on the assembly line at the Subaru of Indiana Automotive, a manufacturing facility in Lafayette, Indiana.
Daniel Acker | Bloomberg | Getty Images
An employee inspects the body of a Subaru Outback, on the assembly line at the Subaru of Indiana Automotive, a manufacturing facility in Lafayette, Indiana.

Stronger-than-expected economic growth smooths the path for the U.S. Federal Reserve to signal a December interest rate hike when it meets next week.

Third quarter GDP growth of 2.9 percent was better than the 2.5 percent that was expected by economists, and it also marked the best pace of growth in two years. With Friday's report, the economy closes in on the 3 percent level some economists had expected to see for the second half of the year.

"Most immediately important is this leaves the door wide open for the Fed to raise rates. They should do it and could do it next week, but they won't," said Jefferies Chief Financial Economist Ward McCarthy. The Fed is widely expected to hike rates for the second time in 10 years at its December meeting.

The figure came despite consumer spending that slowed to a 2.1-percent growth rate after the second quarter's very strong 4.3 percent pace.

"It's a pretty good number. The third quarter turned out the to be the way it looked like it was going to be at the outset — close to 3 percent," said McCarthy. "Spending slowed down. So frankly, it's encouraging we can get this kind of growth with consumer spending that was basically cut in half in the quarter, and I think we'll get something similar in Q4."

Where the growth was

The GDP report was helped by inventories — produced goods that are ready for sale — that contributed to the growth rate, after acting as a drag for the past five quarters. "It's a volatile number," said Jeff Rosenberg, chief fixed income strategist at BlackRock. "The inventory swing from second quarter to third quarter ... was a 1.7 (percent) swing. That's what the GDP quarterly volatility is all about."

Economists raised their tracking forecasts earlier this week after Wednesday's advance goods deficit and inventories data.

Bond yields have been moving higher in a global selloff this week. The 10-year yield initially rose to 1.87 percent after the GDP report, but then was trading little changed at 1.85 percent. The global jump in yield comes as central banks have been signaling less willingness to add to easing programs, and the Federal Reserve prepares to hike interest rates. At the same time, inflation expectations have been rising.

No action is expected at the Fed's meeting next Tuesday and Wednesday, but many in the market believe it could send a signal that it hopes to hike rates at its next meeting, in December.

"What the Fed decides in December is not going to be based on how the economy is doing in the July through September period," said Marc Chandler, head of foreign exchange strategy at Brown Brothers Harriman. He expects the Fed to leave out any messaging about December in its statement and leave its comments unchanged.

"The growth broadened stronger than expected ... but a lot of it is because of exports and inventories. If you exclude exports and inventories, you're looking at 1.4 percent," he said.

U.S. GDP growth rates from Q3 of 2014

2014 - Q3 5.0

2014 - Q4 2.3

2015 - Q1 2.0

2015 - Q2 2.6

2015 - Q3 2.0

2015 - Q4 0.9

2016 - Q1 0.8

2016 - Q2 1.4

2016 - Q3 2.9

Source: Haver