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US GDP: Not quite a recession

Investors reacted well to the announcement of a second consecutive quarter of contraction. The market may have gotten a little ahead of itself.

U.S. real GDP has contracted for two consecutive quarters, constituting a ‘technical recession’, even though the NBER1 don’t consider it as such yet. Instead of a cold shower, the financial markets have welcomed the news rather well. The threat of recession is indeed seen as the only factor capable of stopping the Fed’s aggressive monetary tightening trajectory. But the market may have gotten a little ahead of itself.

Components of GDP (contributions to growth, percentage points)

Sources: BEA, Indosuez Wealth Management.

Numbers

In the second quarter of 2022, the US economy contracted by 0.9% quarterly annualized compared to the first quarter2, which was already down 1.6%. First, the good news: the economic situation has been better than expected on the demand side. Private consumption (~70% of US GDP) increased by 1% on an annualized quarterly basis, thanks to strong demand for services (4.1%) which compensated for the collapse in goods (-4.4% ). This is in line with the monthly data on personal consumption expenditure (PCE) which jumped 1.1% over the month of June, thanks in particular to the fall in the personal savings rate (-0.4 points in T2). Exports rebounded strongly (+18% after -4.8% in Q1 22), while imports weakened in line with the drop in consumption of goods and despite the strength of the dollar. But the good news ends there, as investment plunged 13.5%, dragged down by the housing component (home sales were indeed down 5.4% year on year in June) as well than by inventories, which were replenished at a slower pace than in the first quarter. Non-residential investment remained stable and will be a key indicator to watch over the coming quarters.

Without the negative contribution of inventories, activity would have increased by around 1%.

Public consumption also weighed on growth. In 2021, inventories had significantly supported growth as supply bottlenecks pushed retailers to build more inventory; today, this trend has reversed. U.S. retailers – such as Walmart – lowered their profit forecasts at the end of July, citing the need to cut prices to reduce inventories. Without this negative contribution from inventories (which reduced growth by 2 percentage points in the second quarter, see chart 1), activity would have increased by around 1%, which will bring an upside risk to GDP in the third quarter when the negative effect of stocks will fade. Finally, it is also important to note that this is an “advanced estimate” of Q2 GDP here and that more comprehensive GDP data will be released on August 25th.

Recession: what definition?

Real GDP has contracted for two consecutive quarters, which constitutes a “technical recession”. However, the NBER1, which is responsible for officially determining recessions in the United States, uses a broader approach to define the latter. It takes into account the sum of American spending (gross domestic product), but also the sum of income (gross domestic income, which will be published next month and which increased by 1.8% in the first quarter) as well as a number of monthly indicators (such as non-agricultural payroll employment which remained strong in June). The NBER has therefore not officially declared the US economy in “recession”. This was pointed out by J. Powell at the July FOMC: the US economy is not showing signs of a “widespread decline” in activity affecting many sectors, suggesting that a technical contraction in GDP would not be enough to derail the Fed’s agenda.

That being said, demand should weaken under the weight of Fed actions. July’s numbers left little room for enthusiasm on the demand front, but strong corporate balance sheets and the job market could dampen the impact in the third quarter:
The Michigan consumer confidence survey has recovered slightly, but remains at recessionary levels, while the Conference Board’s consumer survey (which historically has been more tied to changes in the oil market employment) fell 2 points to 95.7 in July;

  • The US PMI survey landed in contracting territory for services in July (at 47, below the 50 threshold) and fell slightly in the manufacturing sector (to 52.3);
  • The housing market, which is the heart of the US economy, suffered a bad blow in July, as the NAHB housing market index fell to 55 points (from 67 in June), significantly below consensus (65). The latter bodes ill for the future of the labor market;
  • Jobless claims – the last domino to fall – are starting to rise (averaging around 250,000 in July vs. 225,000 in June), but still well below their long-term average (410,000) . In such a tight market, wages continued to rise (1.4% quarter-on-quarter in Q2 versus 1.2% in Q1).

Most forecasts for the US economy are out of date unless we have a very big surprise in the third quarter.

With a sharp contraction in GDP in Q1 and Q2 and assuming the economy remains stable with zero growth until the end of the year, the annual GDP growth rate in 2022 would be 1.4% for the US economy thanks to a strong carryover effect from 2021. Most forecasts for the US economy are therefore outdated, unless we have a very significant surprise in the third quarter, which is unlikely. This includes recent IMF projections that the economy will grow 2.3% in 2022 and 1% in 2023 (already revised down by 1.4 percentage points and 1.3 percentage points, respectively) .

Market reaction: happiness is in ignorance?

Financial markets initially rallied following the GDP release, with the threat of a recession seen as the only weapon to stop the Fed’s aggressive monetary policy tightening. On July 28, the S&P 500 rose 1.2%, the Dow Jones 1% and the Nasdaq 1.1%. Bond yields fell significantly: the 2-year US Treasury yield fell to 2.87% (from 2.98% the previous day), while the 10-year yield fell to 2.68% (from 2. 74%). In addition, the markets anticipated a landing in Fed funds rates at 3.24% at the end of 2022 and 2.64% at the end of 2023, i.e. less than expected the day before. This weighed on the dollar which has so far been strongly supported by the interest rate differential. Nonetheless, the greenback could rebound on weaker economic data releases as it remains the benchmark safe-haven currency.

The duration and magnitude of this market rebound will depend heavily on July economic data, with the Fed looking for “compelling” evidence that inflation is slowing. The latter will not be reassured by the recent publication of PCE inflation (up from 6.3% to 6.8% in June). Therefore, this summer, keep in mind the following key dates:

  • August 5: US jobs data
  • August 10: US inflation
  • August 25-27: Jackson Hole Symposium (Fed Statements)
1 National Bureau of Economic Research
2 The equivalent of -0.2% quarter-on-quarter.

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