With two consecutive quarters of decline in GDP the United States has, by some measures, entered a recession, technically. In fact, the National Bureau of Economic Research determines whether the US is in a recession, and they use metrics other than just GDP. That will not stop the headline writers.
Making this technical recession even more ‘technical’ are some of the reasons behind the decline in GDP, which can be traced back to the difficulties in re-opening the global economy after the Covid lockdowns. In the first quarter GDP declined -1.6% and was affected by a surge of imports caused by the delayed unloading of ships due to logjams at US ports in 4Q 2021. Last quarter, the -0.9% decline in GDP included a 2-percentage point detraction due to a slowdown in the accumulation of inventories, from the extreme levels built up by companies responding to supply chain shortages in previous quarters.
Perhaps the best way to view the decline in the past two quarters is to look at them in conjunction with the 6.9% growth in GDP in 4Q 2021, one of the highest prints in 40 years.
But how much does this matter?
In the past, two quarters of declining GDP would likely have spurred the US Federal Reserve into cutting interest rates to stimulate the economy. That is not going to happen. Inflation is at around 9%, well above the Fed’s target of 2%. And despite raising interest rates to 2.5% in the space of five months, Jerome Powell, Chairman of the Federal Reserve, believes they are only now at the point where further rate increases will restrict economic growth, and so bring down inflation. Powell does not believe that the US is currently in a recession – but the Fed’s continuing battle with inflation increasingly risks one.
The reason Powell does not think the US is in recession lies in the strength of the consumer, underpinned in turn by a strong labour market. This view is supported by the current earnings season, which has generally painted a picture of a resilient consumer. Yet while companies such as Nestle, Procter & Gamble and McDonalds have shown the consumer can withstand almost double-digit price increases, they have all sounded caution about the consumer’s willingness to do so in the future.
Recessions can either cause or be caused by a drop in consumer spending – either way it is not good for the economy, or for corporate profits. And while consumer spending increased in the 2Q, inflation is undoubtedly tightening the purse strings.
As the world’s largest economy, a recession in the US matters for UK investors; not just because of the knock-on effect on the UK and the global economy, but also the inevitable impact on global financial markets.
But there are, of course, other reasons to be wary. Europe is facing an energy crisis this winter that will not just pile further pressure on the consumer, but even threaten the functioning of German industry. China is struggling to stimulate its slowing economy beset by its own zero Covid policy and a faltering property market. Its response to Speaker Pelosi’s visit to Taiwan remains to be seen, but it is unlikely to be a positive for its economy, or the United States’.
Whatever the definition, declining GDP is not something to be complacent about. But as it has for most of this year, inflation holds the key to the likely direction of financial markets from here, and whether this technical recession is made official or not.
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