The National Bureau of Economic Research (NBER), a private non-profit, is the self-appointed authority calling the start and end of economic recessions. Two consecutive quarters of negative GDP growth are thought to be sufficient for a recession call, but the NBER makes a subjective interpretation using a variety of data. The 2001 recession, for example, did not have two consecutive negative quarters. So far, the NBER is silent on whether we are in recession or not.
This debate has, not surprisingly, pushed people into opposite corners just like any other topic in the U.S. these days. President Biden and members of his administration maintain that we are not in a recession. The opposition dismisses such claims as nothing but shameless “gaslighting.”
To be fair, economic data is anything but clear, which opens it to interpretation from both sides. While there is no disagreement on the negative GDP numbers, a closer look reveals a complex economic landscape.
To begin with, the 1.6% Real GDP contraction of the first quarter was heavily determined by a 20% surge in imports (which subtracted 2.5% from real GDP). Surging imports are hardly a sign of a sluggish economy, and consumer spending, the largest item by far, increased by 1.8%.
Likewise, second-quarter real GDP would not have fallen by 0.9% if it hadn’t been for a large depletion of inventories that shaved 2% from the total number. Again, inventories deplete because items sell – not a feature of recessions. And consumer spending was positive again.
The economy, therefore, seems to be stronger than what the two negative GDP quarters suggest, and below I list three reasons why that’s the case – and three more for why it is also running out of steam.
1) Growing corporate earnings
Negative profit growth does not necessarily mean that the economy is in a recession, but the opposite is true: an economy in recession always shows negative earnings growth. Profits grew in the past five quarters and, with 75% of companies reporting, they are also higher for the second quarter. It should be noted, though, that the rate of growth is falling rapidly.
2) Solid labor conditions
This may well be the clearest example that whatever the U.S. economy is experiencing, a recession is not it – at least, not yet. The job report for July shows that more than 470,000 private jobs were created, well above twice the expectation and along with a significant upward revision for the prior month. The jobless rate is just 3.5%. The number of job openings as a percentage of the working population is hovering at the highest level in more than 20 years, even after a sharp decline from the March peak.
3) Strong consumption
Consumer spending is still growing, as stated earlier, and other measures are even more robust. Factory orders, for example, are at the top of their 30-year range. Retail sales remain close to record levels any way they are measured – in nominal terms, adjusted by inflation or even as percentage of GDP.
But, despite today’s benign conditions, the data is deteriorating rapidly. This suggests that a recession is almost inevitable in the near future unless the Fed abruptly ends its inflation-fighting war, and there are no hints that they are anywhere close to doing so. Here are three elements that point to a coming recession:
1) Yield curve inversion
The difference between the 10-year and the 2-year U.S. Treasury rates became deeply negative in the second part of July, a signal strongly associated with recessions. Researchers argue that the difference that really matters is the one between the 10-year and 3-month rates, which is still positive but barely, reaching just 4 basis points, or 0.04%, at the beginning of August. Another Fed hike will make it negative too.
2) Declining money supply
One way the Fed tightens policy is by limiting the amount of money available in the economy. Money is a lubricant and during the stimulus years the Fed flushed the economy with it. This is no longer the case. In fact, when money supply is adjusted by CPI, “real” liquidity is actually contracting. This makes sense: If prices go up by 10%, for example, individuals need 10% more money for transactions. If the Fed does not increase money supply accordingly, it is effectively taking money out of the system and restricting economic activity. The eventual, inevitable outcome is a slower economy
3) Decelerating economic activity
While real GDP is the headline number that captures all the attention, it is distorted by the effects of imports and exports and inventory swings, as I described earlier in this post. Economists subtract both items from GDP to arrive at “Final Sales To Domestic Purchasers,” a measure that intends to show what is really happening domestically. It tends to fall before a recession and it is doing so now and heading for negative territory.
Beware of the stock bounce
The market has taken solace in falling commodity prices, thinking that’s a good reason for the Fed to temper its hawkishness. Fed officials, meanwhile, have made clear that they are nowhere near to changing their minds, and the recent job numbers are likely to reinforce that view, especially because wages rose considerably more than expected. Therefore, the market recovery risks to be a short-lived bounce in the middle of an otherwise downward trend. Indeed, fighting the Fed has historically been a losing strategy.
These are not normal times. A thick fog still surrounds the future, and whatever may have happened in the past has little relevance in determining whether the market will go this way or that. Investors should pay close attention to the data in coming months, rather than relying on the recent bounce. Rising stock prices are not enough proof that all danger has passed, and data so far is not encouraging.