US economy shrinks for second quarter in a row

US economy shrinks for second quarter in a row

The US economy shrank for a second straight quarter, meeting one of the usual criteria for a technical recession and complicating the Federal Reserve’s efforts to stem soaring inflation with a series of aggressive rate hikes.

Data published by the Commerce Department on Thursday showed that gross domestic product fell 0.9 percent year-on-year in the second quarter, or a 0.2 percent drop from the previous quarter. This follows first-quarter GDP data showing the US economy shrank 1.6 percent in the first three months of 2022.

Back-to-back quarterly contractions meet one definition of a recession, although the U.S. is dependent on a decision by a group of researchers at the National Bureau of Economic Research that looks at a broader range of factors.

The White House has maintained that the U.S. economy is not currently in a recession, and Treasury Secretary Janet Yellen said earlier this week that she would be “surprised” if the NBER declared so.

She underlined this message at a press conference on Thursday, stressing that the economy “remains resilient”.

“Most economists and most Americans have a similar definition of recession: significant job losses and mass layoffs, businesses closing, private sector activity slowing considerably, family budgets under enormous strain. In sum, a broad weakening of our economy, she said. “That’s not what we’re seeing right now.”

But two consecutive quarters of negative growth will still put additional pressure on President Joe Biden, who is struggling with low approval ratings and has repeatedly touted a strong economy as one of the major achievements of his administration.

Shortly after the data was released, Biden said: “It is no surprise that the economy is slowing as the Federal Reserve acts to bring down inflation.

“But even as we face historic global challenges, we are on the right track, and we will emerge stronger and more secure through this transition. Our labor market remains historically strong.”

Line chart of change in GDP, percent (annualized) showing that the US economy has contracted for the second quarter in a row

At a press conference Wednesday after the Fed raised interest rates by 0.75 percentage points for the second month in a row, Chairman Jay Powell said he does not believe the United States is in a recession. He pointed to strength in the economy, including in the labor market, but noted that growth must slow and the labor market must cool down to curb inflation.

The labor market has yet to show significant signs of weakness, with the U.S. adding jobs at a healthy pace, averaging about 380,000 a month over the past three months. Unemployment also remains at a historically low 3.6 percent, just shy of the pre-coronavirus pandemic level.

“No one would look at two quarters in the United States with 3.6 percent unemployment and call it a recession,” said Claudia Sahm, founder of Sahm Consulting and a former Fed economist. “We are not in a recession in the true sense of the word, which is a broad-based sustained decline in economic activity.”

The fallout from the GDP data rippled through the debt markets. The two-year Treasury yield, which moves with interest rate expectations, plunged, suggesting investors are betting that the Fed may have to slow the pace of rate hikes. The 10-year yield, which moves with growth and inflation expectations, fell to its lowest level since April.

Despite the drop in overall GDP, personal spending, which provides insight into the health of the American consumer, grew 1 percent in the second quarter, compared with growth of 1.8 percent in the first three months of the year.

The biggest burden on second-quarter GDP was a decline in corporate inventories, which removed 2 percentage points from the headline.

Some economists believe this was a lingering effect of last year’s pandemic economy as corporate inventories increased as shelves were filled after supply chain bottlenecks began to ease due to Covid-19. But the decline also reflected the dampening effect the Fed’s rate hikes have had on business investment, economists said.

“Inventory data has been very volatile over the past two years. Inventory management has been very difficult, partly because of the supply chain problem and partly because demand for goods has been red-hot,” said Brian Smedley, economist at Guggenheim Partners.

The sharp interest rate hikes implemented by the central bank in recent months have begun to put the brakes on the economy, and market participants are watching closely to see if this rapid tightening will lead the US into an official recession.

This has been evident in the housing market. The GDP data shows that housing investment fell 14 percent in the second quarter, just as higher interest rates began to pull up mortgage rates. Further increases will give the housing sector further challenges.

Economists said the data was unlikely to change the Fed’s calculation of the way forward for policy.

“I don’t think the GDP print would or should affect the Fed,” said AllianceBernstein economist Eric Winograd.

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