While yesterday's GDP report was an undisputed disappointment, printing at 1.2% or less than half the 2.5% expected following dramatic historical data revisions, an even more troubling finding emerged when looking at the annual growth rate of GDP. This is how Deutsche Bank's Dominic Konstam summarized what we showed yesterday:
The latest GDP release favors our hypothesis of an imminent endogenous labor market slowdown over a more optimistic scenario in which productivity will replace employment as the engine for growth. With real GDP growing at just 1.2%, there is little evidence that productivity is ready to do the heavy lifting. We are particularly concerned because annual nominal growth has slowed to 2.4%, essentially a cyclical trough.
He was looking at the following chart (which as the BEA admitted yesterday, may be revised even lower in coming quarters).
However, as it turns out, that was not even the biggest risk. Recall that even as overall GDP rose a paltry 1.2%, somehow the consumer-driven portion of this number soared, with Personal Consumption Expenditures surging at an annualized 2.8% rate, nearly triple that recorded in the first quarter.
This means that the non-consumer part of the US economy subtracted 1.6% from GDP growth in the second quarter. In fact, as Deutsche Bank calculates, on an annual basis, the non-consumer portion of the economy is shrinking, i.e., in a recession, not only in real terms but also in nominal terms.
This means that excluding the contribution from the US consumer, the US economy is now in a recession. To wit, from DB's Joe LaVorgna:
Business spending is in recession. Equipment spending fell -3.5% in the quarter and is down nearly -2% over the last year. At the same time, spending on structures was down -7.9% in the quarter and -7.0% over the last four quarters. The only pocket of strength within the nonresidential fixed investment sector was intellectual property products; this category, which includes software, R&D, and entertainment, literary and artistic originals, advanced a modest 3.5% in the quarter, and at a similar rate over the last year. While some of the weakness in investment spending has been due to the collapse in oil prices, non-energy-related spending has been soft, too, reflecting weak internal and external demand, excess slack and corporate uncertainty regarding the outcome of this year’s Presidential Election. While investment spending may get a slight boost over the next couple of quarters as the energy investment drag abates, we expect corporate outlays to remain stagnant until next year.
Housing stumbles. Residential investment declined -6.1% last quarter following a 7.8% in the previous quarter. Since the sector bottomed in Q3 2010, it has grown at an annualized rate of 8.6%. Elevated housing affordability coupled with low vacancy rates tells us that residential investment should rebound this quarter and next.
As Konstam adds, "This should further reinforce the secular stagnation thesis, and it will no doubt make the Fed even more cautious in its attempt to raise interest rates. While today’s data do not completely preclude a September rate hike, the hurdle for such a move has meaningfully increased. Going forward, we continue to project middling growth that leaves the economy extremely vulnerable to a negative exogenous shock."
The consumer is the one relative bright spot. Inflation-adjusted spending increased 4.2% in Q2 but grew a trend-like 2.7% over the last four quarters. Despite the collapse in energy costs that began two years ago and the five million-plus jobs that were created since then, the trend in consumer spending has not improved. For example, real consumption was up 2.7% in the four quarters ending Q2 2014, just before oil prices topped out. Consequently, while consumer spending has done well relative to the rest of the economy, in absolute terms, expenditures have been disappointing.
The problem for Q3 GDP, is that the "bright spot" is about to turn very dim:
We should expect a sharp pullback in spending this quarter. Indeed, the recent softness in motor vehicles sales, which are one of our five favorite economic indicators, may be hinting as much. We can see in the chart below that the toppyness in vehicle sales does not bode well for the underlying trend in consumer spending. Besides, as we have written on numerous occasions, gains in consumer spending alone are not enough to prevent a broader economic downturn. There have been numerous economic cycles when year-over-year consumer spending was positive but the economy still entered a downturn. Witness what happened during the 1981 to 1982 and 2001 recessions.
What happens next then?
The 1.2% increase in real GDP in Q2 combined with a 2.2% rise in the GDP deflator meant that nominal activity expanded 3.5% in the quarter. However, the year-over-year growth rate of nominal GDP fell to just 2.4%, the lowest growth rate since Q1 2010 (2.1%). Since the four quarters ending Q1 2010 included the last quarter of the recession, one might plausibly argue that annual nominal GDP growth is at its cyclical trough. This is an ominous sign for corporate profits, which will be reported next month along with the second snapshot of Q2 GDP. Our favorite metric of underlying demand is final sales to private domestic purchasers, which subtracts inventories, government spending and net exports from GDP; this series grew 2.7% last quarter, a nice rebound from very weak readings in Q4 2015 (1.8%) and Q1 2016 (1.1%). However, as we can see in the chart below, the year-over-year trend in private demand is slowing. This is consistent with the profile of overall nominal activity. The downshift in momentum is troubling because, unlike 2012, when nominal activity and underlying private aggregate demand were decelerating but the business cycle was still relatively young, the economy is now more mature. And, monetary policy has effectively exhausted itself, so there is little that policymakers can do to offset any further slowing in demand. With respect to the second half, we continue to project sub-2% growth, a view that we have held for some time.
Sub 2% growth in a world where even the monthly injection of $180 billion in liquidity by central banks is powerless to sustain global GDP growth (just as the IMF).
It also means that one truly unexpected, exogenous shock as monetary policy is already in overdrive, will send not just the US, but the entire world in an all out recession. But at least the Fed has a 25 basis point buffer from where to cut rates should that happen. And that's it: after all every single Fed president has sworn that negative rates would never come to the US, and they never lie...