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Thursday, July 28, 2022

GDP Got Eaten By Inflation

Technically, because GDP was negative for two quarters, it's a recession. However, there are caveats to current economic conditions, which mean if it is a recession, it's very mild. And there's still that pesky 2yr/5yr bond rate inversion (2.9/2.72).

It's inflation that is the beast, which will undo everything.  The GDP Price Index came in at an 8.7% increase, well above expectations of an 8.0% gain and compared to the unrevised 8.2% rise seen in Q1.

By Kelly Evans
The Exchange, CNBC

Why was real GDP negative in the first half of this year? Because inflation ate up all the gains.

The bombshell report this morning showed that real GDP shrank again in the second quarter, by 0.9% annualized, after a 1.6% drop in Q1. But wait, how can real GDP be shrinking while the labor market at the same time added 2.7 million jobs, and the unemployment rate fell from 4% to 3.6%? Because inflation ate up all the real economic gains.

Nominal GDP--actual dollars before any adjustment for inflation--surged by a whopping 6.6% in the first quarter, and 7.8% in the second quarter. That's twice the size of what we used to see in the sluggish expansion of the 2010s. Turns out, it's way more than this economy can actually handle. So the huge nominal GDP boom we've had is all simply going into higher prices; the inflation rate was over 8% in the quarter, and that's how you end up with a negative "real" print.

Was the U.S. actually in recession, meaning the end of a business cycle? Probably not, as we've already discussed. The economic indicators, from the labor market to retail sales to industrial production, were all higher in May than January, and so far for June as well. Just yesterday, new orders for durable goods--a key leading indicator--came in stronger than expected. Orders have steadily risen this year, running as of last month at a 6% annualized pace--which would not be happening at the end of a business cycle. As for leading gauges of the labor market, new jobless claims actually fell last week, to a modest 256,000.

What this all shows is an economy that was overheated by monetary and fiscal stimulus, not one that was too soft or too weak. How else do you end up with 8% surging nominal GDP last quarter, on top of last year's whopping 10% gain? Certainly you don't get that from supply-chain constraints or high oil prices. And because we couldn't handle it all quickly enough as "real" economic gains, instead we simply got higher prices. 

Inflation caused negative real GDP.

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