GDP: The US economy is contracting again, fueling recession fears

GDP: The US economy is contracting again, fueling recession fears

Gross domestic product, a broad measure of economic activity, fell 0.9% year-on-year from April to June. This decline marks a key symbolic threshold for the most widely used – albeit unofficial – definition of a recession as two consecutive quarters of negative economic growth.

The long-awaited data release has taken on paramount importance as investors, policymakers and ordinary Americans seek some degree of clarity in the current messy economic environment.

The negative decline shown in Thursday’s first reading of second-quarter GDP activity – data that will be revised twice more – was mainly driven by a decline in inventory levels. Companies in recent quarters have scrambled to replenish inventories that were drawn down during the pandemic — and in trying to adjust for supply chain upheavals, they have found themselves overstocked at a time when consumers have pulled back on some purchases. Investments in inventories in the second quarter were therefore lower than they were in the first quarter.

“The general takeaway is that the economy is slowing, and it is [Federal Reserve] wants,” said Ryan Sweet, who heads real-time economics at Moody’s Analytics. “We’re not in a recession.”

Although Thursday’s first estimate marked a sharp drop from the 6.7% expansion the economy experienced in the second quarter of 2021, the White House has been adamant that the world’s largest economy, despite being hit by decades of high inflation and a cascade of supply shocks, remains fundamentally sound.

If it looks like a recession and quacks like a recession…
The administration even took the unusual step of publishing some sort of explanation, arguing that two consecutive quarters of economic contraction do not in themselves constitute a recession. The White House posted a blog post last week saying that in addition to GDP, data related to the labor market, business and personal spending, manufacturing and income go into the official determination of a recession.
The nonprofit National Bureau of Economic Research is the official judge of recessions, and it’s unlikely to issue a verdict anytime soon. The group’s Business Cycle Dating Committee typically weighs a host of statistics over a period of months before making a decision.

“They have a much stricter definition: There is a broad-based and persistent weakness in the economy,” Sweet said. “And this is not broad-based. It’s really concentrated in inventories and in trade — trade was a big driver of first-quarter GDP.”

In addition, the labor market is doing well, he said. Monthly job gains averaged more than 450,000 through the first six months of this year, according to the Bureau of Labor Statistics. But while these gains are moderating, as expected, recent weeks have also seen the number of jobless claims rise.

On Thursday, the latest weekly jobless claims data from the BLS showed that initial claims for unemployment benefits were an estimated 256,000 for the week ending July 23. The total is 5,000 below last week’s level, which was revised up by 10,000 claims to 261,000.

“Unemployment claims have definitely moved higher from their cyclical lows,” Sweet said. “I think it’s more a reflection of an economy shifting into a lower gear.”

Economists say the biggest reason it would be premature to call a recession based on Thursday’s numbers is that the data can and probably will change. Subsequent revisions to first-quarter GDP numbers, for example, changed from an initial fall of 1.4% to 1.6%, and Thursday’s figure is just the first of three estimates.

Adjustments are the norm rather than the exception, as the Commerce Department repeatedly refines its calculations as new information becomes available. About a third of initial GDP releases rely on statistical extrapolations and assumptions in the absence of hard data, according to the Federal Reserve Bank of San Francisco.

“These are typically single points in time, snapshots. It’s almost like looking at a balance sheet versus an income statement over a quarter,” said Eric Freedman, chief investment officer at US Bank Wealth Management.

“New information can emerge,” he said, and when it does, those variables change the outcome.

Sometimes the differences between the estimates are significant. For example, revisions to GDP in the fourth quarter of 2008 revealed that economic activity actually plunged by -8.4% year-on-year, indicating a much deeper recession than the original estimate of -3.8% suggested.

Right now, the biggest stain on the lens that prevents economists from getting a clear picture is a build-up of inventories and a corresponding imbalance in the country’s normal trade flows.

“What you’re starting to see and hear a lot about right now is what’s happening with inventory… Inventory is a problem, both in terms of the mix of inventory retailers hold as well as the quantity,” Freedman said.

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A rush to load up on merchandise over the previous two quarters was a miscalculation for companies like big box stores. Walmart and Target have both told investors they expect to cut prices to move products. But from a macroeconomic perspective, some experts believe that these missteps suggest that the economy in the first quarter was not as anemic as the drop in GDP might otherwise suggest.

Anna Rathbun, chief investment officer at CBIZ Investment Advisory Services, suggested the 1.6% decline in first-quarter GDP was artificially low because businesses started stockpiling inventories in the final quarter of last year. This highlighted economic activity that would otherwise have taken place in the first few months of this year, she said.

“The fourth quarter, for me, was a little bit inflated,” Rathbun said. “Everybody just hoarded stuff.”

In addition, when companies import more and export less, that dynamic weighs on GDP, said Jacob Kirkegaard, senior fellow at the Peterson Institute for International Economics.

“It’s the value of production within the physical borders of the United States, so therefore if you hypothetically have exports that are flat and imports are higher, then your trade deficit is increasing. In that sense, an increasing trade deficit subtracts from GDP,” he said, especially when combined with wild fluctuations in prices.

– When you have very fluctuating commodity prices, and especially in periods of high inflation in general, it can be misleading and, in my opinion, paint an overly negative view of where the economy is at, Kirkegaard said. “We have to be careful to say that the GDP figure is the absolutely valid metric for the economic well-being of the country.”

Federal Reserve Chairman Jerome Powell on Wednesday reiterated the importance of considering various key economic measures when the central bank decides on future interest rate movements. However, Powell said the first reading of a GDP report should be taken “with a grain of salt.”

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