Fears of a US recession were at the forefront this morning with the release of the US GDP data, showing a second consecutive quarterly contraction. This comes amid one of the fastest policy normalization efforts in Fed history, coupled with four-decade high retail inflation.
GDP contracted 0.9% in Q2 2022 on an annual basis, coming in above the Atlanta Fed’s 27th July 2022 forecast of -1.2% Y-o-Y. This followed a contraction of 1.6% in Q1 2022.
The confusion of the market in the run-up to the data release was evident with industry estimates ranging from a 2% contraction to a 2% expansion, reflecting the underlying uncertainty spreading through the economy.
According to ING economists, consensus estimates were at +0.4%.
The general slowdown in economic activity is not a surprise with 2021 seeing massive pandemic stimulus, and this year being peppered with supply chain disruptions thanks to both the Russia-Ukraine war and on-again-off-again lockdowns across major Chinese centers.
Jerome Powell in his monetary policy speech yesterday made it clear that “We think it’s necessary to have growth slowdown…we need a period of growth below potential to create some slack so that the supply side can catch up.”
Source: US BEA
The Q2 GDP decrease was driven by falling inventories, lower housing investments, reduced government spending by local, state and federal authorities, and reduced business investments while exports were higher.
Inflation has continued to rise and stands at a four-decade high dissuading discretionary purchases.
Inventory investments were lower following the decrease in retail trade; housing investments were down 14% reflecting the reduction in brokerage amid higher mortgage costs and slowing construction; Federal expenditure fell, led by non-defence expenses; business investments were lower as investments in infrastructure and equipment were subdued; while net exports and consumer spending were higher driven by travelling and demand for services such as food delivery, respectively.
Inventories, the joker in the pack
Source: US BEA
Towards the end of 2021, private firms in the United States invested heavily in inventory build-up to avert global supply chain difficulties. However, most of these organizations significantly overbought given the acceleration in inflation and particularly in essentials such as food and energy, forcing an unwinding of stocks during the quarter.
The unwinding of private inventories led to a -2.1% contribution to GDP, with the BEA, noting that this was due to “a decrease in retail trade (mainly general merchandise stores as well as motor vehicle dealers)”.
An S&P report forecasted a contraction of 1.3% but noted that in the absence of the inventory slowdown, the economy would have likely grown.
The rebound in net trade to the tune of 1.4% kept the economy from slipping further into negative territory. However, the low import contribution (-0.49 %) to GDP could in part represent the tightening of inventories leading to a reduction in foreign orders.
Source: US BEA
In Q2, Personal Consumption Expenditure (PCE) increased at an anaemic 1.0%, which is likely a cause for concern among US policymakers where household consumption is a key economic driver.
If it looks like a recession…?
Market participants often consider two consecutive quarters of contractions to mean that the economy is in a recession. This is not strictly true and does not meet the official start point of a recession, which is determined by an 8-member team of economists at the National Bureau of Economic Research’s Business Cycle Dating Committee.
However, it should be noted that the NBER’s recession announcements are often made once several indicators align, and can even be issued after the economy exits a slowdown.
That is to say, it is possible that the economy is already in a recession but may not be officially designated as such until later.
One of the primary indicators in favour of the economy is the state of the labour market where unemployment is near a historic low.
Unemployment data released earlier today saw jobless insurance applications fall by 5,000 to 256,000, the first decline in four weeks but is near the highest level in eight months.
Nela Richardson, Chief Economist at ADP notes that labour market data is conflicting. Even though job postings are high and hiring has been strong, the proportion of adults looking for work or in work is historically low, while the total supply of workers has shrunk this year.
The moderate expansion in the Kansas Fed’s monthly manufacturing survey released earlier today may boost labour market morale suggesting executives in these sectors across the mid-West of the US are still somewhat optimistic about business conditions.
According to Seeking Alpha, since the second world war a recession has not been declared unless accompanied by a loss of employment, and with job growth averaging 456,700 per month in H12022, this may dissuade the NBER from branding the current economic situation a recession just yet.
However, with fed hikes set to continue, it may only be a matter of time till the labour market begins to unravel.
Another key indicator of a recession, the 2y10y yield curve has stayed inverted for nearly a month.
The predictive power of yield curve inversion can be identified in the image below. The shaded portions represent recessions classified by NBER and can be seen to follow shortly after inversion.
With retail giants such as Walmart cutting their profit projections while raising inventory concerns, this aspect of corporate balance sheets could prove to significantly weigh on future GDP prints.
Firms that can re-balance their inventories quickly may go back to normal production levels sooner and ultimately support the economy. However, with reduced consumption and high costs of living this may be difficult to put into practice.
Jason Schenker of Prestige Economics stated that “We expect 3Q and 4Q 2022 real GDP growth to contract further, as the Fed continues to raise rates to quash inflation, but likely triggers a worsening recession in the process.”
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