We’ve done it. We’ve jettisoned the two-quarter recession definition. And it didn’t take very long, either.
Two business days on from the advance read on second quarter GDP (which, if the two-quarter rule applied, showed the US economy fell into a recession in the April to June period) and virtually no one, not even ardent bears, is unequivocally in the recession camp.
From the very day the advance read on Q1 GDP in the US showed a contraction, I argued policymakers and White House officials would likely be compelled to redefine the generally accepted definition of the term “recession.” That wasn’t a “prediction,” as such. I’m not making any claim to prescience here.
My point, as reiterated at regular intervals, was simple: With the fiscal impulse waning, the Fed hiking aggressively, mortgage rates rising rapidly and inflation stuck stubbornly at 40-year highs to the detriment of consumer sentiment and business confidence, the odds of a small contraction in the second quarter were elevated.
Given the (mostly plausible) arguments for waving away Q1’s contraction by reference to “the way we calculate GDP,” my contention was that officials risked an awkward scenario wherein a quirky negative print for the first quarter was followed by a shallow Q2 contraction, meeting the commonly accepted (if unofficial) definition of a recession, despite a hodgepodge of good reasons to believe the economy isn’t actually in a proper downturn.
That, I suggested, would compel the Biden administration and Fed officials to embark on a PR blitz aimed at demolishing the two-quarter rule. That’s precisely what’s happened. Neel Kashkari joined the effort on Sunday when, during a largely pointless cable television cameo, he told CBS’s John Dickerson that (edited for clarity),
Typically, recessions demonstrate high unemployment and we’re not seeing anything like that. The labor market so far, is very strong. We are seeing some sectors like the tech sector start to shed workers or start to cool hiring. But fundamentally, the labor market appears to be very strong, while GDP — the amount the economy is producing — appears to be shrinking. So, we’re getting mixed signals out of the economy. From my perspective, in terms of getting inflation in check, whether we are technically in a recession or not, doesn’t change my analysis. I’m focused on the inflation data.
Recapping on Monday, BMO’s Ian Lyngen and Ben Jeffery called Kashkari’s remarks “consistent with the FOMC’s hawkish stance.” His comments suggest that “despite the two consecutive quarters of negative GDP (formerly known as a recession), monetary policymakers are on track to bring Fed funds to the 3.25-3.50% range or beyond.” Note the quip: “Formerly known as a recession.”
As discussed at some length in “Help (Still) Wanted,” the Fed needs to dispel the notion that the economy is already in a recession. Because if it is, that suggests additional rate hikes are a policy mistake, unless the goal is to induce a recession in the service of fighting inflation. That may very well be the goal, but until someone at the Fed is willing to admit as much publicly, the rhetoric will continue to revolve around talking points which reference labor market strength in dispensing with the recession story.
For their part, market participants are happy to accept the notion that the economy isn’t severely impaired, but at the same time, both equities and bonds have embraced the slowdown narrative as a rally catalyst. “This dovish pivot speculation has only been bolstered by the clear deceleration of economic data,” JonesTrading’s Mike O’Rourke said. “The advance Q2 GDP report… only reinforced hopes for an earlier pivot as the term ‘recession’ gets redefined.”
This is a very awkward waltz. The Fed doesn’t want the recession narrative, but it may want a recession. The recession narrative, if it runs away from them, could become self-fulfilling through several channels, including a further deterioration in business confidence (to the detriment of investment, which basically flatlined in the second quarter) or, worse, wider credit spreads. It also undermines whatever’s left of the soft landing fable. The market doesn’t want a recession, but risk assets do want the recession narrative, because traders believe the fear of a recession will compel the Fed to pivot earlier. But front-running that expected pivot makes it less likely because rising stock prices ease financial conditions, at the risk of stoking inflation and thereby pushing a Fed pivot further out.
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This is why it’s imperative the Fed doesn’t inadvertently lapse back into forward guidance. They can’t “listen” to the market. They revoked the market’s license to co-author the policy script earlier this year. Now, with inflation showing no signs of abating (outside of PMI price indexes anyway) and rates plainly keen to foist the recession narrative on policymakers (via less aggressive terminal rate pricing and expectations for the commencement of rate cuts in 2023, for example), the Fed needs to ignore the market, even if that risks coming across as capricious.
With apologies to Esther George (who, in her June dissent, emphasized the virtues of retaining at least a semblance of predictability on the road to higher rates), there’s a sense in which Fed policy needs to be a black box when inflation threatens to undermine the institution’s credibility.
In a testament to just how determined the market is to hear what it wants to hear, even the withdrawal of forward guidance was (perversely) interpreted as a dovish development. That’s an incorrect read. A bad bet. As JonesTrading’s O’Rourke correctly pointed out, “forward guidance is the tool of a dovish central bank.” The withdrawal of forward guidance is tantamount to the withdrawal of transparency — dovish outcomes are still possible, but they aren’t guaranteed. If they were, central banks would tell you as much.
More than low rates and asset purchases, it was forward guidance which underpinned the short vol trade in all its various manifestations. The demise of forward guidance is designed to inject volatility or, at the least, it’s tantamount to removing a powerful vol suppressant. While acknowledging that market outcomes are never “wrong” or “right” (they just are what they are, so to speak), a risk-on reaction to the explicit removal of forward guidance is the wrong trade.
“We would equate forward guidance to retailers’ release of monthly same store sales,” O’Rourke went on to say. “When times are great, they want to tell you every month, but when they slow, they drop the practice.”
Forward guidance especially now is undesireable since it can box in a central bank. Right now the FOMC needs flexibility on both the easing and tightening side. By definition recessions include metrics for employment so denying a recession is reasonable even though the back of the envelope rule of thumb is 2 quarters of gdp decline. What is not reasonable is to expect the economy to pick up steam in the face of monetary tightening, fiscal stimulus going away and most leading indicators stalling or going into decline. If the FOMC persists in this path they risk causing a major recession. To everyone on the committee- we get the joke but it is time to slow down and take stock of what you are doing. There is nothing wrong with slowing or taking a break when the trajectory of the economy is rapidly shifting. And to all those talking about inflation spreading- watch wage growth halt and employment go into reverse once the forces of slowdown start to really bite in the upcoming quarters. The change is here, just open your eyes.
“The Fed doesn’t want the recession narrative, but it may want a recession.” That’s it, in a nutshell.
Meanwhile, lost in the forest of terminal rate chatter and such, RIA is right to suggest that they may need to step back and survey the damage as QT really starts to kick in.
Market based indicators, rather than backwards looking economic statistics are all pointing to a slowdown. I wish this were not so, but wishing it will not change things. Employment is holding up for now as employers are hoarding labor as it has been in a supply bottleneck (retirements, covid, reduced immigration, demographics). When the dam breaks on that employers will no longer hoard labor and spend money on unproductive or excess workers. Unless the trajectory changes I expect layoffs to start in about another 2-3 months when this becomes evident to employers.
‘Maybe the Fed should hike 50 bps in March, put an end to press conferences, and sell 50 billion in 10yr notes the next day. Maybe FOMC members talk too much. They don’t keep the market guessing.’
I thought Jeremy Siegel raised an interesting tangential question about this in a CNBC interview today: We added 2.7M jobs in 1H22. How could we possibly do that and still produce 2 quarterly declines in GDP? His take was that this could only happen with an unprecedented (his word) decline in productivity, which we (and the Fed) should seek to understand. He called the 1Q/2Q declines in productivity a “collapse”. If the productivity decline was simply noise or churn and likely to see mean reversion, then there’s some degree of deflationary impetus pending as productivity springs back, which would be helpful. If not, then we have something new to learn about the current labor market and it could support a case for pivot. This, the same morning GOOG’s CEO calls out labor productivity as a major issue for them.
How does the data count retirements? If there are more net retirements/quits than hires we could be adding jobs while simultaneously losing workers and thus have a negative gdp while not suffering productivity loss.
I don’t really understand Siegel’s point. Granted I don’t understand much in macro economics. But my half a cent:
Y = C + I + G + ( X – M )
Y = GDP
C is consumer spending
I is private investment
G is government spending and investment
X is exports, M is imports, X-M is net exports
https://www.bea.gov/sites/default/files/2022-07/gdp2q22_adv.pdf see table 2
2Q22 GDP advance is -0.9% (Y) = 0.7% (C) – 2.73% (I) – 0.33% (G) + [ 1.92% (X) – 0.49% (M) ]
I don’t know if by “productivity” Siegel means “investment”?
Because looks to me like the biggest factor in negative GDP growth was a collapse in investment (biggest I decline since 2Q20), followed by lower govt spend (looks like a trend, with G negative 4 of last 5 qtrs), not fully offset by higher consumer spending (but consumer is fading, was the smallest C increase since 2Q20) and net exports (X-M is volatile, but this was first qtr of positive net exports since, well, 2Q20).
I have little or no ability to analyse or forecast the components of GDP change, but we can at least describe them:
2.73% (I) = – 0.72% fixed investment (almost all was “residential”) – 2.01% inventories (almost all was “non-farm”). In other words, housing investment collapse plus inventory burn. Housing might be pressured for a while, inventory cycles are usually shortish, I think?
0.33% (G) = – 0.20% Federal (all “non-defense consumption”) – 0.13% State and local (all “gross investment”). So both Federal civilian and state spending declined, no idea what this reflects.
1.92% (X) was increased exports (flipped from declining exports in 1Q), and 0.49% (M) was higher imports (but much less increase than 1Q). Could energy exports and inventory burn have something to do with this?
Outstanding effort per usual, H … also extra thanks to RIA and H for recent commentary efforts…current market action makes me think of recent muscle memory response, nothing more…I fully expect Bullard to bring the hawkish heat whenever he’s unleashed next…pretty sure he’s chomping at the bit to do so…GLTA…
I understand the Administration’s and the Fed’s push against the narrative that we are currently in a recession, but they better get their hikes done in a hurry because we’ll likely get another negative GDG read for next quarter based on leading indicators. Raising rates in the face of two consecutive quarters of contraction might is a lot easier than justifying further rate hikes if it becomes plainly obvious recession is a reality and no longer a narrative. The moment of truth for this Fed will arrive soon, we’ll be in what is an undeniably recession with inflation numbers still printing above a 6% YoY, will they blink? I think they will.
H-Man, to get the inflation genie back in the bottle requires strong medicine. Right now it appears the patient is struggling and stronger doses may be required. If a recession is collateral damage, so be it, but right now the focus should be inflation come hell or high water.