The first estimate of Q2 GDP announced on Thursday indicated a 0.9% decline. With the Q1 report, that means the first half of 2022 has seen negative growth, even if the second quarter was a slight improvement on the first. There’s a good chance we’re in a recession, but here’s why we can’t be sure yet.
We have seen plenty of warnings of weak U.S. economic growth from the inverted yield curve to the bear market in stocks. Also, the Atlanta Fed’s GDPNow model should get some credit for calling weak Q2 growth early.
The NBER’s Recession Definition
Two quarters of negative growth, as we’ve seen so far in 2022, is a good rule of thumb for identifying recessions. However, the National Bureau of Economic Research (NBER) makes the final call. That can take some time as they look at all the data and the early estimates, such as we saw this morning, are refined over the coming months.
This is the NBER’s recession definition:
A significant decline in economic activity that is spread across the economy and that lasts more than a few months.
Let’s look at the elements of that in detail.
The NBER fundamentally considers three things in calling recessions. These are depth, diffusion and duration of any economic decline. Given we’ve seen 6 months of negative growth for the U.S. economy the duration test is likely met.
Depth of the decline remains a key question. With declines in economic growth of around 1% to 2% so far in 2022, this is a pretty shallow decline. Calling the current dip in economic growth a “significant decline” may be a stretch.
Often recessions can see the economy decline around 5% or more. So if this is a recession it’s a shallow one, at least so far. The lack of real depth to this decline may prevent the NBER from calling it a recession just yet. However, if this slump persists, the NBER may be forced to call it a recession regardless.
Then diffusion is the most complex of the three parts of the NBER’s definion. Clearly, some sectors of the economy such as travel and energy are doing relatively well today.
On the other hand, we’ve seen big swings in trade, and now some slowing in the retail, automotive and housing sectors as well as slowing business investment in general. This mixed pattern is not unusual. The different parts of the economy seldom move together. Often recessions happen as some sectors boom. The 1970s and 1980s are good examples. The economy hit several recessions, but the energy industry did relatively well throughout.
What Will The NBER Do?
So we’ll have to wait some time to see if the NBER call this a recession. It’s not a simple call. If they name this a recession, it’s a shallow one, so far, compared to most examples in recent history. In a sense, that’s good news for markets, deep recessions are a bigger problem.
It May Not Matter For Markets
Nonetheless, while naming a recession is a debate, the economic situation in the U.S. for 2022 so far is pretty clear. We’re currently seeing a combination of declining growth and very high inflation. That’s essentially stagflation, especially if it persists.
Whether or not it’s a recession is more of an academic debate. Since it’s clearly a proven toxic mix for financial markets, especially since we entered 2022 with relatively optimistic valuation levels.
The question for the the remainder of 2022 is whether inflation comes down significantly and if growth resumes, that rather than the technical call on any historic or ongoing recession is what will likely drive markets.
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