If it walks like a duck and quacks like a duck, then it is probably a duck
Representatives from the Biden Administration as well as from the Federal Reserve seem preoccupied with conveying to the American public that the United States economy has not yet fallen into recession.
And technically, they are correct as the National Bureau of Economic Research (NBER), the body that defines exactly what constitutes a recession defines one as “a significant decline in economic activity that is spread across the economy and lasts more than a few months.”
In addition to the subjectivity of the above statement, the specific criteria the NBER uses in determining exactly what constitutes a recession is only known to a few. Moreover, the NBER quite often determines if a mild recession has occurred only after it has passed.
The reason for the debate is given the fact that the NBER has not made public the specific criteria used in determining exactly what constitutes a recession, economists, as well as others, have made their own definition, that is two consecutive quarters of negative growth in the economy as represented by Gross Domestic Product (GDP), released by the Bureau of Economic Analysis. This past week, GDP for the second quarter was released which showed that the economy contracted at an annualized pace of 0.9% which comes on the heels of a 1.6% drop recorded during Q1.
Several components to the economy negatively impacted second quarter GDP, namely the purchase of both durable as well as nondurable goods, residential and business investment, a decrease in inventories as well as weak government spending.
In addition to the weakness in the data noted above, what struck us as most telling was contained within the update provided by Walmart for their second quarter and fiscal year 2023. This stated that “comp sales for Walmart U.S., excluding fuel, are expected to be about 6% for the second quarter. This is higher than previously expected with a heavier mix of food and consumables, which is negatively affecting gross margin rate.
Food inflation is double digits and higher than at the end of Q1. This is affecting customers’ ability to spend on general merchandise categories and requiring more markdown to move through the inventory, particularly apparel.”
Walmart CEO Doug McMillon noted that “the increasing levels of food and fuel inflation are affecting how customers spend, and while we’ve made good progress clearing hardline categories, apparel in Walmart U.S. is requiring more markdown dollars.” Simply put, inflation is forcing lower end consumers to allocate a larger percent of their budget to the necessities of life thereby leaving less room for the extras.
Toward the other end of the spectrum are customers of Chipotle which reported earnings per share above expectations as the fast casual dining chain has had success raising prices as their input costs have increased. During their earnings call Chipotle’s CEO, Brian Niccol stated that “the low-income consumer definitely has pulled back their purchase frequency. Fortunately for Chipotle, you know, the majority of our customers are a higher household income consumer.”
Due to the level of inflation for necessities exacerbated by the imbalances in the supply chain along with, up until recently too easy of a monetary policy, we would define this economy as one that is weakening and perhaps either having just entered or on the threshold of a mild recession.
However, it is one that the stock market has mostly priced in. That said, should the Fed continue to pursue a policy that seeks to equalize the supply demand equation on those that are already seeing their purchasing power shrink, then the recession may be more severe. That is precisely why, at this time, after having just increased the federal funds rate by another 0.75% this past week, we believe the Fed should raise interest rates by only 0.25% at their upcoming meeting in September and then take a wait and see attitude.
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