GDP Surprises On The Upside, But . . .

It looks upbeat, and much of it is. The gross domestic product (GDP) reported for the second quarter surpassed even some of the most optimistic of expectations. Talk of recession, all but quieted before this announcement, will now disappear, at least for a time. It would, however, be a mistake to let economic optimism run wild. Much in the environment is less than encouraging and should not be ignored.

For the moment, the headlines stand on the positive side of the ledger. Overall real GDP growth came in at a 2.4% annual rate for the spring quarter, well above the consensus expectation of 2.0% and the actual real GDP growth of the first quarter, also at 2.0%. Already the continued strength in hiring had scotched much talk of recession. Now this good news on second quarter GDP will sweep such talk from the media.

But other considerations offer strong reason to curb emergent enthusiasms. Much of the rest of the world exhibits severe economic weakness. Europe by most reckonings is already in recession. Japan is stagnating, and China’s recovery of earlier this year seems to have petered out. Nor can it help the U.S. economy that the Federal Reserve (Fed) is still raising interest rates and is determined to continue along this path until inflation falls firmly back into the vicinity of the Fed’s preferred 2% rate. This kind of pressure will not end soon, as the Fed’s target is still well below the economy’s ongoing core inflation rate of 4.8% as measured for the past 12 months. Such Fed actions may not bring on recession. After all, the economy has stood up much better than most analysts expected when the Fed first began its counter-inflationary policy in March 2022, but this kind of monetary behavior is certainly more likely to create economic weakness than strength.

Even within the detail of the second quarter’s GDP report, signs of weakness are evident. The consumer, fully two-thirds of the economy, is clearly slowing. Real consumer spending expanded at only a 1.6% annual rate during the quarter, far slower than the 2.8% annual pace averaged during the prior four quarters. Evidence that household debt levels have crept up suggests that spending is more likely to slow further in coming quarters than it is to gain momentum. Darkening the picture still more is the news that real spending on goods – always a sensitive indictor of cyclical turns – grew less than 1.0% in real terms this past spring.

Offsetting this fundamental weakness was a surge in capital spending among businesses. Spending on equipment accelerated to an almost 11.0% annual rate in the second quarter. More than a sign of an ongoing pickup, however, this surge seems likely a catchup from the previous four quarters, in which such spending actually fell at a 1.3% average annual pace.

Exports fell faster than imports, which, because of the way the Commerce Department calculates the GDP, detracted slightly from the overall growth figure. That fact is less significant than that both exports and imports fell. The decline in imports reinforces the picture of a consumer slowdown because many consumer products in this country are imported. Meanwhile, the more severe drop in exports points in another way to the gathering effect of the slowdowns and recessions elsewhere in the world.

Another “tell” in the detail of the national income and product accounts is the behavior of inventories. A modest pickup in inventory building added marginally to the second quarter’s overall growth picture. Given the first quarter’s huge depletion of inventories, the rebuilding in spring should have been much stronger than it was. Any number of factors could account for this lackluster inventory response, but the one that carries the most information for the future is that business managers did not rebuild actively because they do not expect sales to pick up very fast. This would apply to both wholesalers and retailers as well as industrial firms accumulating supplies for future production. Had they more confidence in rapid growth, they certainly would have taken the opportunity to rebuild their stocks of inputs and salable goods.

This picture certainly does not say recession. It does, however, offer a warning to optimists that the U.S. economy is not yet out of the woods and that it definitely has not avoided the once widely forecast recession.