The US Economy Contracted for 2nd Straight Quarter, Not Long after Fed Chair Powell & President Biden Dismissed Prospects of Recession

US Economy Contraction

According to today's preliminary data, the US economy contracted in the second quarter, since Q2 annualized GDP was -0.9%. Markets had come to expect that such an outcome would be narrowly avoided, after some solid data, such as yesterday's jump in durable goods orders.

The U.S. Bureau of Economic Analysis (BEA) attributed the decline to "decreases in private inventory investment, residential fixed investment, federal government spending, state and local government spending, and nonresidential fixed investment", noting that these drags were partially offset by "increases in exports and personal consumption expenditures". ^[1]

This is the second straight quarter of negative growth, since the final annualized GDP had dropped by 1.6% in the first quarter of the year. Although there is some debate around this, two consecutive quarters of GDP contraction, generally constitute a recession.

However this is just the first reading and we will have to wait for the revisions and the final figures to make that determination, but things don't look very promising for the US economy at this stage.

Defiant Powell & Biden

Just a few days ahead of the GDP release, US President Biden had denied prospects of recession, saying that "we're not going to be in a recession. And in my view, we are — the employment rate is still one of the lowest we've had in history; it's in the 3.6 area".

Fed-Chair Powell echoed those remarks on Wednesday as he too brushed off recession woes, succinctly stating that "I do not think the US is currently in a recession". The reason for this belief is the many areas of the economy that are performing "too well", and highlighted the strong labor market, which the Fed continues to view as extremely tight. ^[3]

Mr Powell also downplayed the importance of the GDP data - especially the preliminary ones - due the fact that they often get revised substantially, saying that "you tend to take first GDP report I think with a grain of salt".

Despite the Fed's defiant stance, officials did acknowledge yesterday that "recent indicators of spending and production have softened" ^[4], with Mr Powell admitting that "growth is slowing" and the path to a soft landing has "clearly narrowed".

Monetary Policy Implications

The Fed has embarked upon a very aggressive and front-loaded monetary tightening path in order to bring surging inflation down, having delivered 225 basis points worth of rate hikes, after Wednesday's back-to-back 0.75% move.

The plan does not seem to work very well for now, since inflation hit fresh four-decades high recently, as Headline CPI jumped 9.1% in June year-over-year and as long as it does not begin to drop, it will be hard for the central bank to stray away from its current path.

With the labor market still very strong and unemployment at historically low levels (3.6%) it still has the ability to remain committed to the inflation part of the mandate. However, it is clear that Mr Powell was more reserved yesterday and tried to lay the groundwork for less aggressive rate hikes ahead, saying that "it likely will become appropriate to slow the pace of increases"

GDP Growth is not part of the Fed's mandate, inflation and employment are, but obviously it is a data set that that officials "we'll be looking at".

It does seem to us that there may be some wishful thinking in regards to the prospects of a recession and it is not like the central bank has not been wrong before. They underestimated surging inflation by sticking to the "transitory" narrative, but they were eventually forced to make it their top priority and tighten aggressively.