GDP declines, but recession can still be avoided
July 28, 2022
U.S. Gross Domestic Product (GDP) declined for the second consecutive quarter in 2Q 2022, stoking concerns that a recession has arrived. However, CONTI Capital doesn’t believe recessionary conditions have been met, and a recession could still be avoided.
The 0.9% decline in inflation-adjusted economic output in 2Q reflects weakness in private inventories, housing and government spending.
The most dramatic change in the economy over the past quarter is the residential market. Residential investment plummeted by 14% during 2Q, reflecting the sharp slowdown in single-family sales that we have been tracking the past few months. This slowdown has occurred as rising interest rates have sidelined many buyers of residential properties. Though home prices have recently begun to moderate, rising interest rates have rapidly pushed upward on mortgages, causing many potential homebuyers to shelve their purchasing plans for the time being. Importantly, demand for housing is still extremely high – but homebuying is simply too costly for a large chunk of the population.
Consumption—the largest component of economic output—increased by 1.0% at a seasonally adjusted annual rate. The U.S. household has remained financially robust, bolstered by a tight labor market. However, this is the slowest rate of consumption growth since the start of the pandemic-driven recession. As a result, we feel consumers still have discretionary cash to spend, but they’ve curbed spending as inflation has remained elevated.
Prior to today’s GDP numbers, we lowered our economic growth forecast for 2022 to account for the more aggressive Federal Reserve interest rate hikes, accelerating inflation and the souring consumer. In their most recent effort to pump the brakes on inflation, the Fed instituted another 75 bps rate hike on Wednesday.
Counter-balancing the recent negative economic data releases is the very strong U.S. labor market, which gives us some confidence that the country may be able to avoid recession this year. There is a common misconception that two quarters of negative growth is enough to declare a recession. In fact, the agency that declares recessions takes a more holistic approach that incorporates the strength of the labor market, consumer and business spending, income growth and industrial activity. CONTI does not believe a true recession will occur until the unemployment rate increases by 0.3 to 0.5 percentage points.
The negative growth reading this quarter was less pronounced than 1Q, when the economy contracted by 1.6%. However, it’s clear that components of the U.S. economy are still decelerating. Once again, volatile components of the economy, including inventories and government spending, weighted heavily on economic growth. The collapse of residential fixed investment was expected, given the impact of rising mortgage rates on affordability and home sales.
As with our previous positions, the fundamental challenge facing the U.S. housing market is one of limited supply confronting strong demand. Indeed, the Fed’s goal in rapidly increasing interest rates is to temper demand so that supply can “catch up,” per Chairman Jerome Powell. There’s still a decent chance the economy will reach the “soft landing” that policymakers are striving for, slowing economic growth and cooling inflation while keeping the economic engine running smoothly.