A small improvement to the forecast leaves Q2 GDP at 0.7%
But first: Recession talk is just...talk
Don’t run for the hills yet!
Ironically, while my GDP forecast improved---along with two of the three Fed Bank forecasts I follow---talk this week turned to recession. Apparently, we have to be worried about something, and if it’s not inflation, it must be that the economy is about to tank, As a prime example, consider Heather Long’s discussion of the Sahm rule (https://www.washingtonpost.com/opinions/2024/07/09/economy-recession-risk-sahm-rule/),
It’s true that the rise in unemployment is troubling, and I share the sentiment that the Fed should probably consider lowering rates. The Sahm rule remains a useful measure for understanding the economy. But like all measures, you have to use some intelligence to interpret it.
But recessions don’t just happen. They are the result of a shocks, sudden shifts in underlying relative prices (that’s the technical economic language). Often this takes the form of a change in perceived riskiness, which sounds bloodless until you realize that it describes stuff like bank run, spectacular financial failures, wars, and (now) pandemics.
In 2019, I wrote a piece about this that I stand by (plus my then team leader loved the title):
In that piece, I discussed the three types of shocks behind pretty much all the recessions/depressions/panics in US history: policy mistakes, bursting financial bubbles, and sudden shifts in supply. I didn’t mention pandemics, but the 2020 recession very much proves my point. Recessions don’t just happen: something has to break first. Now I have four types of shocks to describe, instead of the original three. But the rest of the piece remains accurate.
The Fed has tightened aggressively, but given the relative health of labor markets after more than two years, it’s hard to believe that this is the type of policy mistake that could create a recession. Of course, if the Fed keeps rates up for too long, something could indeed break. But nothing has yet (although we came close).
We already avoided one potential breaking point in the current recovery, but nobody really noticed. In the past, the failure of an institution like Silicon Valley Bank could well have created the risk repricing that would send the economy into a downward spiral. But the Fed, and other US banking regulators, prevented that from happening Other risks remain (just read about commercial real estate lending). The mistake would be not to take those risks seriously.
But the current slowdown by itself won’t create a recession. The vulnerability of the economy may be increasing, but I wouldn’t put much weight on the possibility of a recession in the next few months. I get that journalists like doom and gloom stories; they attract more readers than stories about how good things are. I read them, too! But the truth is that current data shows no real sign of a recession, and is consistent with a slowdown to growth at the economy’s long-run potential of between 1.5% and 2.0%.
Could something unexpected throw the economy into a recession? That could happen any time. Let’s just hope that it takes years before I have to add a fifth type of unexpected shock to my list.
The Current Quarter model is up 0.2 points to 0.7%.
The lower than expected didn’t change the forecast for real consumer spending. But the PPI was also lower than expected. And, in the model, the PPI for capital goods is the price adjustment term for shipments of capital goods, and the PPI for goods is the price adjustment term for inventories. The result: real equipment investment (which is determined by real shipments of capital goods) and real inventories were both higher this week.
Two of the three Fed models also showed improvement. The Atlanta Fed’s GDP Now had dropped to 1.5%, but rose to 2.0%. That’s particularly striking since, at this point, the main forecast changes are happening to monthly data for the end of the quarter. Those changes tend to have less impact than new information about months at the beginning of the quarter. So the data must have surprised the Atlanta Fed’s model quite a bit. The New York Fed’s GDP Nowcast was up as well, by a smaller 0.2 percentage points.
It all suggests that recent data is relatively positive. The coming week includes some important indicators of activity: retail sales, housing starts, and industrial production. That will give us some high quality information about whether this week’s positive trend can continue.
