The US economy contracted at a 1.4% annualized rate during the first three months of 2022, the initial read on Q1 GDP, released on Thursday, showed.
The headline print (figure below) was expected to betray a sharp deceleration from the robust pace of expansion witnessed during most quarters following the pandemic downturn. It wasn’t, however, expected to show a contraction.
To be sure, the negative print wasn’t a total surprise. Consensus called for a 1% pace of expansion, and there was no shortage of speculation around a prospective trip into sub-zero territory.
However you want to frame it, the US is now one quarter away from a technical recession.
Downturn fears proliferated during the first quarter, when some measures of consumer sentiment dropped to decade lows amid generationally high inflation.
The war in Ukraine and new lockdowns in China threaten to keep producer and consumer prices elevated. The conflict in eastern Europe and Beijing’s “zero COVID” strategy will also act as a drag on growth. The IMF and the World Bank slashed their forecasts for the global economy last week.
American consumers were somewhat resilient in Q1, Thursday’s data suggested, but at 2.7%, personal consumption was notably weaker than the forecasted 3.5%, and barely better than Q4’s pace (figure below).
That bodes poorly. Survey after survey shows perceptions of buying conditions are the worst they’ve been in decades. And wage increases aren’t keeping pace with inflation.
Note that the price indexes printed 8% and 5.2% on headline and core, respectively. The former was far higher than expected, the latter cooler.
The figures are “a troubling” start to the year considering the Fed “has only delivered a single 25bps rate hike,” BMO’s Ian Lyngen remarked. It’s very difficult to square the Q1 data with expectations of 225bps of additional rate hikes in 2022.
As expected, trade and inventories were severe impediments, exerting 3.2pp and 0.8pp worth of drag, respectively. Government spending fell 2.7% against expectations for a small gain. Business spending was a bright spot and residential investment held up.
In retrospect, it should’ve been obvious (figure below). And to some, it was.
Analysts will find silver linings. Narratives about “savings buffers” and “healthy” household balance sheets will persist. And (almost invariably) the financial media will suggest market participants should “look through” fluctuations in inventories and the impact of trade.
Some such attempts to explain away weakness will have merit. Others won’t. Just as some recession banter is more credible than others, depending on the source.
As ever, I’ll stick with what’s indisputable: The headline print was below zero and the miss on the personal consumption side wasn’t trivial. You can draw your own conclusions.
Oh, and don’t forget: Everything has happened faster this cycle. Viewed through that lens, it’s possible to suggest the traditional lag between yield curve inversion and recession will be compressed.
Algos led a modest sell off on the GDP news. As the humans mind their algos, the bad news is good news paradigm will be back, result: (overblown) expectations for rate hikes decreases, indexes shake the correction, growth equities become the hot “new” trend. Today was likely the pivot.
Also, expecting a sell the news event (meaning equities up) when the 50 bps rate hike is announced, along with a dovish pivot in regards to what comes next, meaning no hard commitment to any additional hikes.
So far you’re right on the money!
“Oh, and don’t forget: Everything has happened faster this cycle. Viewed through that lens, it’s possible to suggest the traditional lag between yield curve inversion and recession will be compressed.”
Yep. We old timers ae not used to this. Among our cohort or model-based economists.
Sadly, the most vocal proponents of choking the economy at the Fed are only following the Taylor “Rule” which is based upon two lagging indicators.
I very much would like to think that all of this is going to have less impact than one may initially imagine. It may even just blow over like a brief summertime thunderstorm. I think like you, regarding inflation. But Putin’s hideous war on Ukraine and his nihilistic demeanor these days gives me pause.
You and I have seen more serious inflation in our lifetimes. So, by itself, today’s inflation might be less of a concern because it’s not the mystery it was before. We can examine consumer and producer behavior, and the movement of money in the US economy against the experience we have with inflation in our economy. But our experience today, and the world in which we live, differs from what we know. And the war presents ugly wildcards.
As the war in Ukraine unfolds and the economies of the world cringe in response, we, in the US, will not be able to view ourselves in geographic isolation, as we have historically seen ourselves. At least, not to same degree. And we do yet know whether (or how far) the conflagration between Ukraine and Russia will spread.
Now, just in time, comes on the scene the Fed chairman, Jerome Powell, to manage our inflation. I’ve read that some say the Fed should have slowed the money printer and raised rates modestly 3-4 years ago. I hoped at that time that this would happen because of a mistrust I had (and still have) for printing what I see as insane volumes of dollars to gloss over what seems (to me) to be a potentially serious mess, and a serious risk to the well-being of the US economy. With all this time and money-printing in the rear-view mirror, I have a question: How many bullets and practical tools does the Fed have to confront the challenges presented by today’s inflation? I hope it is more than what it appears to be in the eyes of this investor.
Coincidentally, in addition to the Fed taking action against US inflation, major economies around the world continue to experience a lag effect from the pandemic. Just take a look at China’s growth in Q1 as one example. On top of this we also have a substantial, if not great, war, still evolving. The pricing of oil products, shipping, trade, and the financial systems of countries around the world are being impacted by this war – severely in some.
In the midst of all this, Powell has his firm hand on the controls available to the Fed, which doesn’t provide a lot of comfort. How long before the US feels the impact of the war on our economy? How “great” will the war itself become? How great will be its impact?
As a long-time fan of Charlie Munger, I believe in buying good companies at a fair price. I take comfort in the fact that his advice generally works well. But the potential ocean of cold water being splashed on the world’s economies by the war in Ukraine has me worried. The inflation we see at the moment may be a product of our own mismanagement (courtesy of the Fed). But it may be just an initial taste of what is to come. I hope I am incorrect, and “everything” turns out fine. But I’m doubting it will be fine. There’s just too much bad, and potential bad happening.
Also, strong though household balance sheets may be, much of that balance sheet is illiquid–it’s investments tied up in retirement accounts and physical property. Sure you can take a cash-out mortgage, but at a shitty rate. You can tap your retirement savings, but with a penalty. Much easier to just tighten the belt and buy less stuff.
I have been bearish about the economy but in fairness a look through to the components suggest this may be a one off. Inventories are no doubt affected by supply chain issues- they went down, but they tend to be mean reverting as long as sales don’t crack. Net exports were also a negative component, but upon looking at the release the cause was imports going up. That indicates demand for imports is good because consumers want to consume. However, if this ends up being the first shoe to drop and consumers pull back due to inflation or other reasons, we could get a full blown recession far earlier than the vast majority of analysts believe. If I am at the Fed, maybe i would go 50 this time, since I shouted from the rooftops, but after that it is going to be a far tougher call to keep on raising rates. I am not a proponent of adjusting the balance sheet at all. But again the Fed shouted from the rooftops- a superior strategy would be a very slow reduction there and perhaps rather than shrinking too fast maybe the Fed should look at shortening the duration of the balance sheet and allowing mortgages to roll off. (Translation- reinvest only is shorter UST bonds and bills – like 2 years or less and let the balance sheet duration shrink gradually. This would tend to steepen the curve and alllow mortgages to widen vs. UST bonds other things equal.)
BTW to counter my above argument take a peek at DXY (dollar spot index). It is over 103 now, which is scary territory if one looks at the chart. The $ has not been this strong since early 2020….
The latest report showed significant consumer price increases but for my money it’s the PPI that I fear more. As long as prices to business are rising, the CPI can’t go down much.