What Happened?
The first release of Q2 GDP data shows that the US economy contracted 0.9% on a quarter-over-quarter annualized basis. This contraction follows a reported contraction in Q1 of 1.6% which will cause most media outlets to claim that the US is in a recession. While that may turn out to be the case in the future, we think it’s a small likelihood that it is today. A discussion of the ways in which the National Bureau of Economic Research (NBER) makes business cycle determinations is available here—as you’ll read, the NBER does not say that the definition is two consecutive quarters of negative GDP and, in fact, goes out of its way to push back against that definition. The top-level summary is that a lot more than GDP goes into the discussion, and most of the other variables typically considered, in our opinion, still point to continued expansion. In the first half of 2022, for example, the US added more than two million jobs—a far cry from recessionary conditions. And yet, we also don’t think it matters very much. A semantic debate about whether the economy is or is not in a recession isn’t useful from an investment perspective. GDP tells us what happened several months ago and has only limited utility as a forward-looking indicator.
That Aside…
The data show that the real economy slowed in the second quarter, in large part because of inflation. The GDP price deflator was +8.7%, meaning that even with a robust 7.9% nominal increase in final sales to domestic purchasers, “inflation-adjusted” final sales fell. On a forward-looking basis, the good news is that demand is still there and, if inflation moderates, that should allow for a positive outturn from this important category in Q3. Further to that point, personal consumption (i.e., consumer spending) made a positive contribution to GDP in Q2 despite the price pressures. That positive contribution was offset by a contraction in government spending and in private investment.
The Big Driver of the Decline
The biggest detractor from GDP was inventories, which accumulated at a much slower pace in Q2 than Q1, and as a result, subtracted roughly two percentage points from GDP. The slowing accumulation is consistent with reports from major retailers that they have an inventory overhang to work through. There tends to be something of a pendulum effect in the way that inventories feed into GDP. Unusually large accumulations like Q3 and Q4 of last year tend to be followed by large drawdowns, like Q1 and Q2 of this year, and vice versa. That suggests some scope for inventories to rebuild later this quarter, assuming that demand stays stable. The other big swing in Q2 was net trade, which made a large positive contribution to GDP after having been the primary driver behind the Q1 contraction. The stronger dollar is likely to lead to renewed weakness next quarter as US exports get more expensive and foreign imports to the US cheaper.
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GE-4877969.1 (08/22) (exp.08/24)
