July 25, 2022
Gross Domestic Product (GDP), Second Quarter 2022 (Advance Estimate) is scheduled for release by the Bureau of Economic Analysis on Thursday, July 28, 2022, at 8:30 AM Eastern Time.
The first quarter had negative GDP growth, with the economy shrinking at a 1.6 percent annual rate. It is very possible that we will see negative growth again in the second quarter. This does not mean we are in a recession.
In fact, both consumption and investment are likely still growing at a healthy pace, as they did in the first quarter, with the former rising at a 1.8 percent rate and nonresidential investment growing at a 10.0 percent rate. If we see negative growth in the second quarter, it will be primarily due to a slower pace of inventory accumulation.
Going forward, final sales of domestic products to domestic purchasers will be a better measure of the strength of the economy. This figure, which removes both the effect of inventories and changes in the trade deficit, grew at a 2.0 percent annual rate in the first quarter. It will almost certainly be positive again the second quarter.
Consumption Continues the Shift from Goods to Services
Consumption of goods, especially durable goods like cars and appliances, exploded during the pandemic. It has been shifting back to services over the last three quarters. This trend is likely to continue in the current quarter. Durable goods consumption has been especially weak, in large part because auto manufacturers are still hampered by the semiconductor chip shortage.
Consumption of durables will likely fall again in the second quarter. Consumption of nondurable goods is also likely to fall in the quarter, as people respond to higher prices for food and gas.
Consumption of services is likely to rise at more than a 3.0 percent annual rate as households spend more on restaurants, travel, and hotels. This will ensure a modest positive rate of growth consumption overall.
People are Not Spending Down Their Savings
There have been many reports that households have been spending down their savings in recent months, based on a drop in the reported saving rate. This is a misunderstanding of the data.
Saving is the portion of disposable income that is not spent. Disposable income growth has been weak in recent months, not because income growth has been weak, but because people are paying more taxes. The rise in tax payments is not due to higher tax rates but people paying income taxes on capital gains from selling stock.
The capital gains from these sales are not counted as income. However, the taxes on capital gains are subtracted from disposable income. A clean measure of the extent to which people are spending down their savings would look at how the path of tax payments and savings combined as a share of personal income. Since tax rates are not changing, this measure would remove the effect of increased payments of capital gains taxes.
Investment is Likely to Remain Strong
Nonresidential investment is likely to again show strong growth in the second quarter, with investment in equipment and intellectual products both growing at nearly double-digit rates. While surveys show increased pessimism about the economy from corporate executives, orders for capital goods continue to be strong.
Residential Investment Will Be Negative
The housing sector is likely to be a drag on growth in the second quarter, as housing starts have fallen in response to the jump in mortgage interest rates in April and May. The fact that house prices are so much higher now than they were before the pandemic means that builders should still have plenty of incentives for new construction, even with higher rates, but there is no doubt that higher rates will have an impact.
High rates have also ended the refinancing boom, with refinancing mortgages now down by close to 80 percent from year-ago levels. The services associated with mortgage issuance are down close to 0.5 percent of GDP, so this plunge in refinancing mortgage will be a hit to residential investment, in addition to ending a channel for homeowners to save on interest payments.
Inventories
A slower pace of inventory accumulation is likely to be a major negative in the second quarter data. Businesses increased inventories at an extraordinarily rapid $188.5 billion annual rate in the first quarter. With non-auto inventories now far above pre-pandemic levels, businesses no longer have a reason to build up inventories at an especially rapid pace, and many may actually be looking to cut back inventories.
A normal pace of inventory accumulation in the years before the pandemic would be around $60 billion annually. If the pace of accumulation falls back anywhere near this rate in the second quarter, it will take more than two percentage points off the growth rate for the quarter.
The positive side of a big drop in the pace of accumulation is that it is likely to be a one-off story. If the rate of inventory accumulation falls back to near its normal pace in the second quarter, inventories are not likely to be a major factor slowing GDP in future quarters.
The Path Forward
Despite widespread talk of a recession in the media, it is difficult to see the basis for one unless the Fed gets bullied into continuing on a path of rapid rate hikes. Even if Wednesday’s release shows us with two consecutive quarters of negative growth, the NBER committee will not likely say we are in a recession. The economy does not generate 400,000 jobs a month in a recession.
The rate hikes to date have impacted growth, most notably in the housing market. But with unemployment still low and most households still having savings from the pandemic, it is unlikely that we will see major cutbacks in consumption. Similarly, businesses have not put their expansion plans on hold, even with rising fears of recession.
We should be on a sustainable path of modest growth as long as the Fed is measured in its interest rate hikes in the months ahead.
