Is 5.9% GDP growth in the third quarter realistic?
Jerome Powell spoke at Jackson Hole last Friday, and didn’t break any new ground on the Fed’s guidance. Powell emphasized the Fed’s commitment to the 2% inflation target and said they would be careful in making further rate increases. Powell referred to the current situation as navigating by the stars on a cloudy night.
Powell said that "We are attentive to signs that the economy may not be cooling as expected….At upcoming meetings, we will assess our progress based on the totality of the data and the evolving outlook and risks. Based on this assessment, we will proceed carefully as we decide whether to tighten further or, instead, to hold the policy rate constant and await further data.”
Other Fed speakers at Jackson Hole echoed Powell’s thoughts and stressed that the work on inflation is not done. The Fed Funds futures became slightly more hawkish. The markets still see a 80% chance of no increase at the September meeting, but see a 60% chance of a hike in November if we don’t get one in September. Larry Summers advocated for further rate increases.
The conundrum for the Fed is that the economy remains resilient in the face of rate hikes. The expected layoffs simply aren’t occurring. Wage growth remains elevated.
Another part of the Fed’s hawkishness is based on the Atlanta Fed’s GDP Now model. For some reason, the Atlanta Fed’s GDP Now index sees almost 6% GDP growth in Q3.
This number was mentioned several times during the Jackson Hole summit, but how realistic is this forecast? A 6% real GDP growth rate is highly unusual, and is typically seen at the beginning of recoveries, not after long expansions. The last time we saw this type of growth was in the aftermath of COVID when the economy re-opened. Prior to that, it was in the early 1980s, coming out of the 81-82 recession which at the time was the deepest recession since the Great Depression. It generally occurs in major rebounds after the Fed has cut rates to boost the economy.
Consider the situation today. We are in an expansion that has lasted since COVID. We haven’t seen rate cuts. The idea that we would see GDP growth of 5.9% after 500 basis points of Fed tightening seems highly unlikely. Note that the forecasts from the Blue Chip survey of Street economists sees growth between about 1% and 2.5%, which seems more realistic.
The ISM surveys show manufacturing is contracting, and the service economy is just barely expansionary. Here are some comments from the latest ISM manufacturing survey:
“Current U.S. market conditions of inflationary and recessionary tactics affecting overall business. Customers are reducing or not placing orders as forecast, (putting) internal focus on reducing financial liabilities and overhead costs.” [Computer & Electronic Products]
“Sales in our industry are extremely slow entering into the second half of the year, and no upturn is expected until at least the fourth quarter.” [Chemical Products]
“Demand is softening. Some pricing starting to decrease. Back orders mostly resolved.” [Transportation Equipment]
“Stable demand for the next four to six months, but longer-term uncertainty. While customer growth is projected, we cannot point to fundamentals that sustain it. Supply conditions are similar to pre-pandemic, except for energy and raw input costs. Logistics costs have settled, transit times continue to shorten and capacities at most suppliers are sufficient.” [Fabricated Metal Products]
Does that sound like the strongest economy in 40 years? I just don’t see it.
The Atlanta Fed shows the components of its model, and the two components pushing it higher are consumption and housing. The mid-August retail sales report and housing starts numbers seem to have been the catalyst.
In July, housing starts rose 3.9% month-over-month and 5.9% higher than July of 2022 to a seasonally-adjusted annual rate of 1.45 million units. Starts were 23% higher in early 2022. Building Permits were flat month-over-month and down 13% on a year-over-year basis. Supposedly this number was the catalyst to revise upward housing’s contribution to GDP from -0.02% to +0.42%? I am just not seeing it.
July retail sales rose 0.7% month-over month and 3.2% on a year-over-year basis. The retail sales numbers are adjusted for seasonality and trading days, but not for price changes. The July annual increase in the CPI was 3.2% as well, which means retail sales were flat on a year-over-year basis. Yet somehow this number pushed up the Atlanta Fed’s estimate for consumption’s contribution to GDP growth from 2.17% to 3.29%. Granted, the tepid retail sales number was partially due to gasoline, but demand simply does not seem that strong. Don’t forget that student loan repayments are beginning after being paused since 2020. This will act as a wet blanket on consumption.
Suffice it to say that a recession doesn’t appear to be in the cards, but IMO there is something weird happening with the Atlanta Fed’s model. The preponderance of the economic data shows an economy in the midst of a long and moderate expansion. Yes, the labor market remains strong, but housing starts are more or less at historical averages. The ISM data shows manufacturing is contracting and services are barely expanding. The numbers from the retailers aren’t all that great: Walmart comp sales were up 6.4%, while Target was down 5.4% and Home Depot was down 2%.
This Atlanta Fed number just doesn’t make much sense given the facts on the ground. But it is a driver of the hawkishness coming out of the Fed overall.