Over the past few months, we have argued that we do not see an imminent risk of recession (within calendar year 2022). Yes, growth is slowing at the margin, but the labor market is still strong, and consumer demand remains robust by many measures.
However, calls for recession from market participants and the financial media are growing louder. With the Federal Reserve intent on hiking interest rates until inflation stabilizes, growth pressures may compound in the coming months. Enter: the Atlanta Fed, whose “nowcasting” tool (GDPNow) estimates that growth contracted by 1.5% in Q2. Paired with the 1.6% growth contraction in the first quarter of this year, this model implies that the U.S. has already been in a “technical” recession for the first half of 2022.
Estimates for Q2 growth are declining, with “nowcast” pointing to recession
Sources: New York Life Investments Multi-Asset Solutions, Bloomberg Finance LP, Federal Reserve Bank of Atlanta, as of July 18, 2022. QoQ refers to quarter-over-quarter comparison. SAAR: seasonally adjusted annual rate. The GDPNow is the Atlanta Fed’s nowcast, or live estimate of U.S. GDP, which is a model built from a broad range of economic indicators and live-updating as each is released.
What should investors make of all this? Below we dive into the most pressing questions about the U.S. economy and recession.
What is the difference between a “technical” recession and a true recession?
There are two common definitions of recession. A widely used definition of a “technical” recession is two consecutive quarters of GDP contraction—and this is what has occurred in 1H 2022 if the Atlanta Fed turns out to be correct.
However, this designation is not officially used by the Bureau of Economic Analysis—the main economic statistical agency of the U.S.—and is simply a “rule of thumb” among economists and financial professionals. The National Bureau of Economic Research (NBER) instead defines recession as “a significant decline in economic activity that is spread across the economy and that lasts more than a few months.” We take the NBER definition as a “true” recession because it more accurately reflects recessionary conditions for businesses and households.
The job market seems strong – how can we be in a recession?
We will find out if we are in a technical recession when the official Q2 GDP data is released on July 28.
Regardless of how this release turns out, we do not believe that we are in a true recession based on the other economic measures we saw in Q2. The economy remains at full employment and activity, and although slowing at the margin, is still robust.
By pointing in the direction of a technical recession, the Atlanta Fed estimate is not necessarily pointing to hidden risk simmering in the economy. The GDP estimate has simply been dragged down by a slowing in inventory buildup. See below* for more detail.
Should households be concerned?
Today’s environment may well feel recessionary for many Americans—but the impact that’s felt is currently inflation-related, not growth related. Though wallets are feeling strained, we believe the strong labor market (including strong wage growth) and leftover savings from the pandemic should continue to support household consumption on aggregate.
If we are in a technical recession, does this affect your growth expectations for the rest of the year?
No. Above, we stated that we are constructive on the U.S. economy through 2022, but that growth will slow as the Fed continues hiking interest rates. The existence of a technical recession driven by uneven inventory behavior does not pull forward or push back our expectations for a growth slowdown.
Putting a finer point on our view: our recession model tracks the behavior of a large number of economic indicators around historical recessions—with some overlap of the Atlanta Fed’s GDPNow. It currently points to rising and significant risk of recession in the coming 12-month period—nearly 50-50 odds—and a 77% probability of recession in the coming 24-month period. Using this model and our own qualitative analysis, we expect a true recession at some point in 2023.
The MAS team’s recession model suggests a broad-based slowdown is likely in 2023
Source: New York Life Investments Multi-Asset Solutions team proprietary model-based estimations, July 2022. These recession risk estimates are generated from the team’s machine-learning model, based on recognizing patterns in a large number of economic indicators around historical recessions. These include the labor market, business/manufacturing activity, oil prices, and corporate earnings, among others. For illustrative purposes only.
Would a technical recession mean anything for asset allocation?
No. We don’t position for data technicalities, though we won’t be surprised if next week’s financial media and market emotions are dominated by recession talk, possibly accompanied by a brief period of heightened volatility. We expect such noise to fade as the market understands and digests the data.
Even more importantly, we believe it is too early to position for the kind of true, broad-based recession we see as a key risk for 2023. For this year, we favor approaches that attempt to find resilience amid market volatility and resilience to today’s inflationary environment. These include an overweight to value equities; a quality lens in both equity and fixed income allocations; and exposure to the commodities complex. See our team’s Midyear Outlook for more details on actionable investment ideas.
*More information on the Atlanta Fed’s GDP Nowcast
Why is the data saying we are in a technical recession in the first place?
In a word: inventories. The change in private inventories was the single largest contributor to the expected contraction, dragging the Q2 estimate down by 2.5 percentage points on its own. This negative contribution has two components: first, while inventories are still growing, they are doing so at a much slower pace than last quarter. Second, the pace of inventory growth disappointed throughout the quarter: this negative contribution was only -1.13 percentage points at the start of the Q2 Nowcast.
With inventories driven by imports, Q1 and Q2 had nearly opposite inventory and import behavior - but may see mirrored contractions.
*How should we interpret this?
We attribute the slowdown in inventory restocking as a natural, and nearly opposite, consequence of the inventory buildup of Q1.
Q1’s GDP contraction featured the opposite narrative from Q2 because imports and inventories have been closely linked. In the first quarter, growth was dragged down by net exports: the U.S. imported more than it exported, as companies attempted to meet robust demand and rebuilt inventories as supply chain strains eased. Inventory building usually boosts GDP—because the creation of goods spurs economic activity—but when the dramatic inventory buildup was largely imported in 1Q, it created a growth drag through net exports. In Q2, that import drag appears to have eased, but the slowdown in inventory building has pulled down the growth estimate.
The GDP contractions of Q1 and Q2—assuming the Nowcast is at least directionally correct—share one commonality: they are technicalities based on the ongoing recovery from the pandemic.
This material represents an assessment of the market environment as at a specific date, is subject to change and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding any strategy, issuer or security in particular.
The opinions expressed are those of the Multi-Asset Solutions team, an investment team within New York Life Investment Management LLC an indirect wholly owned subsidiary of New York Life Insurance Company and an affiliate of New York Life Investments.
“New York Life Investments” is both a service mark, and the common trade name, of certain investment advisors affiliated with New York Life Insurance Company.