This is Not the Recession You are Looking For

Q1 preliminary GDP estimate shocks at -1.4%, vs. expectations of about +1.0%
We have been saying growth is decelerating, but Q1 is not as bad as it first appears
PCE (Personal Consumption Expenditures) have reverted to pre-pandemic levels
The pandemic recovery continues to make data twitchy and we expect positive Q2 GDP growth
We believe a recession is coming, but it’s not here yet

Recessions are defined as at least two consecutive quarters of negative GDP growth. By that standard, we are half way into a recession, but that conclusion jumps the gun. GDP data remains influenced by the dislocations of the pandemic as well as the dislocations caused by the very rapid recovery and that is the reason for the negative GDP print for the first quarter.

Recall that in the fourth quarter, GDP was unusually high due to inventory building. In the first quarter, inventories were down almost 1% sequentially (although still up significantly year over year). Net imports and exports were a huge drag at -3.21% vs. -0.22% in the fourth quarter. The chart below shows how volatile GDP has been not only during the pandemic, but during the recovery. We are still not back to normal, and with China still under lockdowns, we do not expect to be back to normal soon.

The Consumer is Back Where They Started

What we find particularly interesting in the first quarter data is that the American consumer is essentially right back where they started, albeit, spending a bit more on services and less on goods than they were pre-pandemic. The chart below shows Personal Consumption Expenditures (PCE) broken down into 2 categories – Goods and Services. The chart shows the dramatic drop-off of services expenditures as COVID hit, which is logical as services often require personal contact. Goods declined modestly as COVID began. Again, there is logic here as we stocked up on goods to ride us through the pandemic.

In 3Q 2020, Services staged a comeback, but did not nearly get back to where they were and demand for goods took off, rising 10% in just 90 days! Goods demand has now generally been weak since 3Q 2021, while services has picked up the pace.

But now, we are getting back to normal. To refresh some memories, recall that in the years leading up to the pandemic, the Fed was trying very hard to get GDP growth to accelerate and to get inflation up to its 2% target (which is hard to believe as we sit here today!). In those quarters leading up to the pandemic, PCE growth was a relatively meager 1.62%, comprised of 0.71% from goods and 0.91% from services.

Over the last two quarters (see below), PCE growth is modestly higher at 1.8% with goods running at 0.13% and services at 1.67%.

PCE is about 70% of total GDP, so it is the main driver of economic growth and that is quickly returning to exactly where it came from. We still have more volatility to come from fluctuations in imports and exports and inventory corrections, but those are not the long-term drivers of economic growth; PCE is.

Our points are simple:

If PCE growth has effectively returned to the disappointing levels of several year ago, AND
If the Fed tightens financial conditions (i.e., raises interest rates and sells bonds/drains liquidity) they will be pushing the core of GDP growth lower.
We then have a problem and that problem is a high likelihood of a recession.

But the negative growth in the first quarter is not the recession we are looking for.