• October 7, 2022

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Topline

A highly watched economic indicator with a good track record in predicting recessions cut its forecast for second-quarter gross domestic product growth this week, implying the nation has fallen into a technical recession despite economists, although increasingly bearish, widely calling for a return to growth in the second quarter.

Key Facts

The Federal Reserve Bank of Atlanta’s GDPNow model on Thursday projected the U.S. economy shrank 1% in the second quarter, slipping into negative territory after economic data showed consumer spending dropped in May, while domestic investments, another component of GDP growth, also fell.

The model, which estimates GDP growth using a methodology similar to the one used for the Bureau of Economic Analysis’ official estimates, has been steadily trimming its second-quarter GDP forecast based on updated economic data that’s fueled concerns of a prolonged economic downturn in recent weeks.

The U.S. economy unexpectedly shrank 1.6% in the first quarter as the omicron variant fueled a record surge in Covid cases, so another negative quarter would indicate the nation has slipped into a technical recession, which is defined as two consecutive quarters of negative GDP growth.

“The model’s long-run track record is excellent,” DataTrek analysts wrote in a note to clients Thursday night, pointing out its average error has been just 0.3 points since the Atlanta Fed started running it in 2011—but was zero through 2019, before unprecedented volatility around the pandemic.

With an error margin of 1.2 points one month before the government’s first GDP estimate, the model may still ultimately forecast positive growth for the quarter, DataTrek’s Nicholas Colas and Jessica Rabe noted, though they add the indicator will be “important to watch” as its predictive ability improves with time.

Most economists are still predicting a return to growth, with average projections calling for GDP to increase more than 3% last quarter, but many have become increasingly bearish in recent weeks, with Bank of America’s Ethan Harris on Friday downgrading his forecast to zero growth last quarter (from 1.5% previously) after the weak spending data for May.

What To Watch For

The Bureau of Economic Analysis unveils its first estimate of second-quarter GDP growth—or decline—on July 28, but it won’t release a final estimate until September.

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Tangent

Adjusted for inflation, consumer spending fell for the first time this year in May, according to Thursday’s data. The worse-than-expected decline makes a second-straight quarterly decline in GDP “much more likely,” Pantheon Macro chief economist Ian Shepherdson wrote in a Friday note, forecasting GDP fell 0.5% in the second-quarter. However, he notes the National Bureau of Economic Research—”the semi-official arbiter” whose declarations are accepted by the government—”very probably will not” declare a recession unless employment, which remains one of the economy’s strongest pillars, starts declining as well. Rather than purely going off technical recessions, the NBER vaguely defines a recession as “a significant decline in economic activity that is spread across the economy and lasts more than a few months.”

Contra

Despite growing bearishness, many economists aren’t convinced the U.S. will fall into recession—at least not imminently. In a research note on Monday, analysts at S&P Global Ratings said the economy has enough momentum to avoid a recession this year, but warned “what’s around the bend next year is the bigger worry.” The economists put the odds of a recession in 2023 at 40%. One week earlier, Morgan Stanley put the odds at 35%.

Key Background

Fueled by government stimulus and the war on Ukraine, prolonged levels of high inflation pushed the Fed to embark on the most aggressive economic tightening cycle in decades—crashing markets and sparking recession fears. “People are really suffering from high inflation,” Fed Chair Jerome Powell testified before Congress last week, noting it remained “absolutely essential” for the Fed to restore price stability, before acknowledging it would be “very challenging” to avoid a recession while doing so.

Further Reading

U.S. Economy Shrank Worse-Than-Expected 1.6% Last Quarter As Recession Fears Grow (Forbes)

Cathie Wood Claims Economy Already In A Recession—Warns Inflation And Inventories Pose ‘Big Problem’ (Forbes)

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