U.S. first quarter GDP disappoints
The U.S. economy had perked up in the second half of 2022, with growth averaging near a modestly above trend 3%. However, this came on the heels of declines in GDP in the first half of last year, and it quickly proved unsustainable in the environment of high and rising interest rates and the banking crisis. Growth has been trending lower and decelerated more than anticipated in the first quarter of 2023, to 1.1% at an annualized rate, highlighting the continuing threat of recession facing the economy.
Over the four quarters of 2022, the economy grew a disappointing 0.9%. While year-over-year growth perked up to 1.6% for the first quarter of 2023 as comparisons eased, the Moody’s Analytics baseline forecast has it receding to about 1.3% by this year’s fourth quarter, though this assumes no recession and could be revised lower given the weak first-quarter growth.
Many believe the higher interest rates and problems in the financial system will push the economy into recession at some point in late 2023 or early 2024. A coming downturn would also be consistent with many tried and true leading indicators of recession. Most notable is the deep inversion of the Treasury yield curve. The Conference Board’s leading economic index presages a similarly dark economic outlook. The index is a compilation of 10 indicators that have historically led recessions.
The crisis that swept the nation’s banking system last month was quelled by the government’s muscular intervention, including the U.S. Treasury’s effective guarantee of all bank depositors, the Federal Reserve’s emergency provision of liquidity to the system, and the FDIC’s quick resolution of troubled institutions. Nonetheless, it has undermined the outlook modestly and reversed a seeming waning of recession risks. The biggest channel by which it has impacted the outlook is a reduction in credit availability, especially for small businesses and commercial real estate. It is worth noting that the bank failures occurred in mid-March, too late to have any identifiable impact on first-quarter data.
While the economy will struggle in response to the Fed’s actions intended rein in the high inflation and the fallout from the banking crisis, our baseline outlook holds that the Fed will be able to slow growth and bring down inflation without precipitating a recession. That is, it will be able to raise rates high enough to sufficiently quell the wage and price pressures, but not so high that it fully knocks the wind out of the economy. This is a scenario that we might well call a slowcession—growth that remains very weak but that never slips into reverse.
Obviously, while the baseline forecast calls for the economy to skirt but avoid recession, risks are extremely high. It would take little to push the economy into recession. Among the more obvious risks are more financial system problems, a spike in energy prices, a monetary policy misstep, or a flair up of some international hot spot like Ukraine, China, or the Middle East, but there are many more risks as well.
Manufacturers on shaky ground
New orders for durable goods surprised to the upside in March, rising 3.2%. However, the details of the report were far less impressive. Total durable goods orders remain tethered to the volatile transportation sector, which saw a surge in new orders of defense and nondefense aircraft in March. Excluding transportation, orders increased 0.3%. While most non-transportation sectors saw an uptick in new orders, the pace of growth has fallen off considerably during the past year.
More concerning, however, is the trend in new business investment.
Core capital goods orders, a useful leading indicator for new business investment, have declined for two straight months and are down in four of the last five months. The downshift in new capital spending reflects weaker demand for goods and manufacturers’ increasingly pessimistic outlook. Making matters worse, high interest rates and tightening lending standards in the aftermath of the banking crisis will further reduce the demand for expensive durable goods.
Most data on manufacturing activity have been downbeat to start the year, and the ISM manufacturing index for April—to be released next week—is likely to continue that trend.
The Empire State manufacturing survey surprised to the upside and moved back into positive territory in April, but data from the Dallas, Philly and Richmond Feds all moved in the opposite direction and slipped further negative. Combined with the recent weakness in durable goods orders, this does not bode well for the near-term manufacturing outlook.