The world’s largest economy is in a recession. Sort of.
The Atlanta Fed’s GDPNow tracker fell into contraction territory for the second quarter on Thursday (figure below), suggesting the US is on track to meet the textbook definition of a recession this summer.
The new estimate followed a disappointing look at personal consumption, insult to injury after the final read on first quarter GDP came packaged with a large downward revision to the spending component.
The nowcast’s estimate of real personal consumption for Q2 dropped a full percentage point in the latest update, to 1.7%, while the nowcast for gross private domestic investment tipped a drop of 13.2%, compared to a projected 8% decline earlier this week.
This comes with the usual caveat: GDPNow isn’t an official forecast of the Atlanta Fed.
Nevertheless, the optics aren’t great. No Fed official is on the record calling for a recession. And yet, a running estimate produced by one of their own models shows that as of the last day of the second quarter, real GDP growth was negative.
I’ve wondered aloud if policymakers will be compelled to effectively reimagine and rewrite the definition of recession in 2022. The same goes for the White House. Time and again, Jerome Powell and Janet Yellen have played down the odds of a recession, as though the economy weren’t teetering precariously on the brink of a downturn — just one negative print away from a deluge of national media coverage trumpeting the dreaded “R word.”
The Fed has a bad enough credibility problem without having to explain why they couldn’t see a recession that was literally already happening. Tragic irony atop tragic irony is the fact that any downturn which does materialize will be blamed in part on the aggressive nature of the Fed’s tightening campaign, which is itself the product of last year’s forecasting error.
Unlike forecasts which emanate from economists, the GDPNow estimate includes “no subjective adjustments.” It’s all numbers. As the Atlanta Fed puts it, GDPNow “is based solely on the mathematical results of the model.” And the model uses a methodology designed to mimic that employed by the BEA.
Although I doubt Wall Street economists will be any more excited than Fed officials when it comes to adopting a US recession as their base case, it’s probably time to at least consider it. If not now, then when? A forecast isn’t a forecast if it’s delivered after the fact.
Much of this so reminds me of the consensus chatter in 2008. You may recall that many/most were underestimating or were oblivious to the leverage out there had yet to be wrung out of the economy.
Now we have different structures and different bagholders, but the outcome is likely to be the same. The party’s just begun!
In my opinion, a recession has been the default scenario for some months now, with the start date looking more likely each month to be in 2022 not 2023.
Now here we are, with the Fed in the early innings of tightening, and estimates, multiples, and prices all have to go lower. I gather that most portfolios have yet to be shifted to outright defensive stances, so we have that to look forward to.
SP500 needs to descend to the low 3000s, typical stock needs to descend to Dec 2019 levels, and once there investors can assess what is the key question now: “what kind of recession?” A long, deep recession with severe earnings declines, high unemployment, and the Fed continuing to tighten? A short, shallow recession with significant earnings declines, modest unemployment, and the Fed shifting from tightening to easing? Some other unwelcome combination?
From SP500 3250 (or generally thereabouts), the next move will depend on how that question gets answered.
I think the major factor will be inflation, whose trajectory will dictate the Fed’s actions for at least the next several months, which is probably long enough for the next die to be cast.
As such, I’m looking for the Street to turn its analytical tools even more to inflation forecasting.
It’s not clear to me that inflation over the next couple months is a “one-way bet”. Crack spreads are falling, crude is not showing much conviction, commodities of all sorts are coming in, market indicators of future inflation are softening, and on my last trip to the supermarket I was surprised at all the items on sale and how not-shocking my final bill was – not “low” but not as “high” as I’d expected.
My best guess is more on the “shallow” side, but I don’t have enough conviction yet to make a big bet. Inflation stuck at 8% with no sign of easing by Sept has very different market implications than inflation easing to 6% and clearly easing by Sept. If anyone has a cogent argument for one or the other, I’m all ears.
For now, neutralizing portfolios as much as feasible and settling down to “wait and see” is probably a reasonable course of action. Not a satisfying one – most of us feel better making bold bets – but no-one said this job was always going to be fun and exciting.
A real summer vacation? How unfamiliar an experience that will be.
I’m keeping in mind, from one of H’s recent articles, a potential scenario for a quick fade to inflation. There do seem to be some elements of that forming up (in my admittedly hope-biased view). Commodity selloffs have indeed been quite significant and the weakness has not just been at the front end. In the last week, I’ve seen commentary that supply chain is cleaning up, China commentary on weak mfg orders in recent PMI, Micron today reinforcing other news flow that semis are suddenly facing a supply glut (a total 180 from the situation just months ago), and the obvious response throughout retail to inventory overhang. PMI mfg could start reflecting weakness fairly soon in some components. Not clear when this might show up in actual inflation data, but it may show up sooner in inflation expectations remaining at less-threatening levels in anticipation of better numbers. I’m personally cheering on a quick and convincing recession to line up with a quick fade scenario.