‘Recession Over’ Jokes Mask Weaker US Economy

Rejoice. The US has exited recession.

There’s some sarcasm in there. Don’t miss it.

After meeting the “technical,” but unofficial, definition of a recession in Q2, the world’s largest economy expanded at an ostensibly lively 2.6% annual pace during the third quarter (figure below), the advance read on Q3 GDP showed.

That was better than expected. Consensus was looking for 2.4%. The range of estimates, from nearly six-dozen glorified weather forecasters, was -0.3% to 3.3%.

Personal consumption beat, which was good news. The 1.4% pace counted as the second slowest since the pandemic plunge (figure below), but headed in, consensus expected to see the “first slowest,” if you will.

Data due Friday will give market participants a granular look at spending in September.

According to commentary from the nation’s largest banks, there’s scant evidence to support the notion that the US consumer is tapped out, even as revolving credit balances are up sharply. Quarterly results from consumer-facing companies suggest Americans have absorbed price hikes with relative alacrity thus far. That’s somewhat vexing for the Fed. If consumers are willing to pay up, corporates will raise prices, leading to stubborn inflation.

Speaking of inflation, the core PCE print in the GDP report was 4.5%, in line, but down from 4.7% in Q2. The headline price index rose just 4.1%, far less than expected. I suppose the overarching takeaway there is that the underlying trend (i.e., core) remains hopelessly disconnected from the Fed’s 2% ambitions.

Nonresidential fixed investment rose 3.7% during Q3, the government said. That represented a marked rebound from the prior quarter’s moribund pace. Residential investment plunged 26.4%, though, after falling 17.8% in Q2 (figure below).

Q3’s drop very nearly matched that seen in Q2 of 2020, when the US briefly experienced a depression, with a “d.”

“Residential investment is now exerting a massive drag, given the rapid slowdown in housing transactions,” ING’s James Knightley said. “This component shaved 1.4% off the overall GDP figure in the third quarter, a symptom of a housing market that is moving from a period of significant excess demand to one with modest excess supply.”

The figure (below) shows the breakdown by contribution. This is where the picture gets a bit murky. Net trade was the biggest contributor by far. Investment was a drag and consumption chipped in the less than a percentage point.

Apropos, durable goods orders missed for September, separate data out Thursday showed. Non-defense capital goods orders ex-aircraft dropped 0.7% last month, and shipments fell 0.5%.

Here’s the thing: Once you get past the headline rebound and exhaust all the frivolous jokes about what does or doesn’t count as a recession, the read-through from the advance read on GDP appeared to be that the economy is in fact slowing. Consumption is tepid, investment is likely to decelerate going forward, inventories were a drag and the housing market is a mess. Final sales to domestic purchasers rose just 0.5%, up from Q2 but still very anemic.

And yet, at the same time, the labor market is holding up, wages are still growing rapidly and tepid or not, consumers are still spending. So, the risk is additional Fed tightening with no real way of assessing how the tightening already delivered will eventually manifest across the economy.

If the housing market is any indication, then the drag from what, by year-end, will be 425bps of tightening in just 10 months, is likely to be severe. It’s just a matter of when and where it shows up.

“Rising borrowing costs throughout the economy and the strong dollar are creating a massive headwind,” ING went on to say Thursday. “While the US may have just exited a technical recession, the cold winds are set to get a whole lot chillier this winter and make recession feel much more real in early 2023.”