Today, the US Bureau of Economic Analysis (BEA) announced 2Q GDP that was down .9%. It’s not a big number, but it is a negative one, and that, combined with negative GDP growth in the first quarter means the US is officially in a recession. Washington D.C. politicians, political operatives, media allies, and the White House in particular are busy insisting that the “R” word doesn’t mean what it really means, that we need to consider all kinds of other factors, and that we need to wait many months for an obscure government agency to make an official declaration.
Again, we fully understand why no politician wants to be tagged with the recession label on their watch, but this is where our economic policy and Congressional overspending has taken us. Whether anyone in Washington DC wants to admit it or not, economic activity has slowed at the same time that inflation has eroded Americans’ buying power. American citizens don’t care about the argument over official labeling. They do care that family savings are increasingly being tapped to pay for food, fuel, and housing.
Because few in DC care about being consistent, these same politicians are also insisting that Fed rate hikes will cause the economy to tip into recession. There’s a problem with that kind of political messaging. By broadcasting that even though we’ve had two negative quarters that we’re not in a recession, it gives Federal Reserve Chairman, Jerome Powell, the political cover to continue to raise rates. That’s the exact thing these same politicians are trying to avoid. (We do note for the purpose of remaining non-partisan and accurate that politicians of both parties are guilty of insane overspending and that both parties have engaged in messaging of questionable effectiveness. There is plenty of blame to be shared on both sides of the aisle.)
During his press conference yesterday, Powell made it clear that he didn’t think the US was in recession and telegraphed that he wouldn’t be swayed by today’s negative GDP print.
We like to adjust the numbers to correct for temporary noise and improve accuracy. The change in private inventories was down by 2.0%. That’s a fancy way of saying that retailers have a little less inventory on the shelves. Over time, inventory adjustments even out and while today’s numbers mean retailers are a little more pessimistic on consumer buying power, we adjusted GDP down for inventory restocking in December, so we adjust up for the same in June.
The other number we look at is the inflation adjustment which was 8.2% for the quarter. That’s how the BEA accounts for the increase in prices over time. If a loaf of bread costs $1.00 last year and the same loaf of bread costs $1.08 this year, it’s still one loaf of bread and not an 8% increase in economic activity. The problem is that the adjustments made by the BEA are based on the Consumer Price Index (CPI). That’s fine in times of low inflation, but we’ve made the point dozens of times on this blog that the CPI is hugely understated right now (especially for shelter and food). We believe that the actual inflation number is closer to the mid-teens so we’d adjust the current price index up by another 7% – 8%.
Adding it all up, we have negative .9% stated GDP plus 2.0% inventory adjustment less 7.5% inflation understatement. That means our adjusted calculation of GDP is around negative 6.4%. According to our adjusted GDP numbers, this is the third negative quarter in a row. Again, the media and politicians can argue we’re not in a recession, but Americans who are seeing their standard of living fall won’t care about the official definition.
A few items from the BEA report caught our attention. We suspected that there might be a flurry of government spending to ensure the GDP number came out positive and allow politicians to avoid the recession label. In fact, government spending slowed. That’s partly because we’re coming off of a couple of years of huge Covid shut-down spending, and partly because the Administration has decided to sell off a huge part of the strategic petroleum reserve (SPR). The report made a point of specifying that the SPR sales didn’t affect GDP because those sales ended up in private inventory. Still, it’s worth noting that after the midterms, the US is going to need to spend a lot to replenish the reserve assuming we still want to keep it in case of an emergency. Further, the SPR is at very low levels heading into hurricane season so if something knocks out refining capacity in the southeast, it’s going to be a big problem.
The report also outlined a decrease in residential fixed investment (homes) that was due to lower brokers’ commissions. We’ve written previously about how transaction volume drying up was the first step in getting to lower housing prices, and lower broker commissions would be another indication of exactly that issue. We expect that as housing inventory builds, and higher interest rates make housing less affordable, we’ll continue to see a slowdown of housing starts. Given that a house is expensive and uses materials from dozens (or hundreds) of different sources, that will weigh on GDP statistics going forward.
Last point is on the market impact. While we believe that the economic slowdown is going to lead to lower earnings estimates for the S&P 500, the market is up solidly today. The reason for that is the expectation that if we can declare a technical recession, it will put pressure on the Fed to back off of the rate hikes sooner and get back to more of the fun 0% interest rates and quantitative easing. That might happen, but with the petrodollar system in the process of being broken, more dollar printing won’t continue to be free; but rather, result in a comparable loss of purchasing power from everyone holding dollars. It might be fun for the market for a while, but will simply lead to a reintroduction of high inflation.