Economy rebounds in third quarter, but outlook sours
On Thursday, the U.S. Department of Commerce released its latest Gross Domestic Product (GDP) report. GDP is defined as the total dollar-value of goods and services produced by the economy. It serves as the key indicator on the health of our economy.
Robust GDP growth reflects a strong and vibrant economy. An increase in consumer and business demand for goods and services must be accompanied by an increase in production and employees to meet that demand. This translates to rising wages for employees and greater disposable income. For companies, economic growth means greater corporate profits, resulting in higher stock prices.
In the July-September third quarter, the economy grew at an annualized rate of 2.6%, exceeding Wall Street’s forecast of 2.3%. Personal consumption expenditures, which captures the consumer spending component of our economy, grew at a fairly modest 1.4% annualized rate. This was slightly below the 2% growth rate posted in the second quarter. Consumer spending accounts for roughly 68% of our nation’s entire economic growth.
The third quarter’s growth rate of 2.6% marked an end to the “technical” recession of the first and second quarters. A technical recession is defined as two consecutive quarters of negative economic growth. This was met when the economy contracted by 1.6% in the first quarter and by 0.6% in the second quarter.
The first and second quarter economic contraction, however, was not deemed an “official” recession. This declaration is made by the National Bureau of Economic Research (NBER), a non-profit research organization based in Cambridge, Mass. The NBER considers other factors besides economic growth – such as the labor market, consumer spending and industrial production – in deciding whether the economy has or has not entered an official recession. With consumer spending, the labor market and other facets of the economy still fairly strong, the NBER declined to label the first and second quarter contraction as an official recession.
Despite the third quarter’s return to positive growth, the economic storm clouds on the horizon are beginning to darken. There’s a growing concern the economy will dip back into a recession in the second half of next year. The national unemployment rate is expected to rise from its current level of 3.5% to 4.5-5% by the end of 2023. High inflation and rising interest rates are expected to put a substantial dent in consumer and business spending. The once red-hot housing market is already showing signs of wear-and-tear. In other words, many of the once-strong components of the economy that prevented the NBER from declaring an official recession could soon start to fade.
The rather dire economic projections being made begs the question – how can Wall Street predict a recession nine to 12 months down the road?
To help keep inflation under control, the U.S. Federal Reserve has begun an aggressive agenda of raising interest rates. In fact, it’s been the most aggressive pace of rate hikes by the Fed in 42 years. Higher interest rates make it more expensive to buy goods and services on credit. Consumers will be charged a higher interest rate on their credit cards, bank loans, car loans and home mortgages. Businesses will be charged a higher interest rate to borrow money for their purchases of inventory and supplies, equipment, technology or to expand their operations. The Fed hopes these higher interest rates, and thus, higher costs, act as a disincentive to spending which should help keep rising prices in check.
The problem, however, is that the surge in interest rates takes a punishing toll on consumers, businesses and, ultimately, the U.S. economy. The fallout is expected to impact the labor market, consumer spending, industrial output and many other facets of the economy. Historically, it takes six to nine months for the impact of these rising interest rates to filter their way through the economy. As the Fed is projected to continue raising interest rates through the first few months of 2023, that puts the timeline for the expected recession to hit in the late summer/early fall of next year.
The extent of the projected recession is unclear. Will it be short and mild or much more severe and long-lasting? As of now, nobody can say for sure. But Wall Street’s alarm bells are ringing and the cautionary red flags are being raised. As the weeks and months progress, Wall Street will be dissecting the latest economic data to help find those answers.
Mark M. Grywacheski, Investment Advisor
Quad Cities Investment Group is a Registered Investment Adviser.
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