Applying Prof. Edward Leamer’s pre-recession progression paradigm to the present

 

 - by New Deal democrat

Twenty years ago Prof. Edward Leamer gave an important speech at the Fed’s Jackson Hole, WY, retreat called “Housing IS the Business Cycle.” In that speech he discussed the fact that, historically, private residential construction as a share of GDP on average peaked 7 quarters before the onset of recessions, followed by motor vehicle and other durable goods sales, followed by consumer durable sales, and then the coincident indicators of recessions.

Let’s take a look at what that progression looks like at the moment.

First, here is Leamer’s noted measure of housing as of Q2’s GDP, both in nominal (blue) and real (red) terms:

In real terms, housing as a share of GDP peaked in Q1 2021. Nominally it peaked one year later, in Q1 2022. After stabilizing for awhile, both measures had secondary peaks in Q1 2024. The present readings are the lowest since before the pandemic.

My preferred way of looking at housing is the historical progression of peaks during expansions: first, single family permits, then housing units under construction, and then employment in residential construction and new housing units for sale. Here’s what that looks like currently:

Single family permits peaked in 2021. Units under construction did not peak until October 2022. Residential construction employment probably peaked in March, although it is only down -0.2% since then. And new homes for sale have not turned down yet. 

Next in Leamer’s line of progression are durable goods, starting with vehicles. Here is the most recent data for heavy truck sales (red) and light motor vehicles (blue):

In past cycles, heavy truck sales have declined earlier and far more unambiguously than car sales. The same appears to be the case at present, as heavy truck sales peaked two years ago and have declined more than -10%, a typical pre-recession decline. Car and light truck sales actually increased in late 2024, and even moreso with the front-running of tariffs earlier this year.

Looking at the broader durable goods picture, manufacturers’ new orders for durable goods increased in 2024 and have trended generally flat so far this year. Real purchases of durable goods appear to have trended similarly, although it is more ambiguous given the big jump last December and slump in January, which may just reflected unresolved seasonality:

Finally, manufacturers’ new orders for non-durable consumer goods has trended generally sideways for almost two years, while real spending on non-durable goods has continued to trend higher, albeit at a very attenuated pace since March of this year:

Putting it all together, housing is clearly down, even counting from its secondary peak 18 months ago, suggesting a likely time for recession by roughly the end of this year. Heavy truck sales are also down enough to signal a recession is near, although the signal from light vehicles is unclear to say the least. Broader durable goods orders and sales may have been in the process of peaking in the first half of this year; but consumer goods orders and sales are still trending higher.

Among the signs I am looking for to determine if my current “recession watch” should turn into a “warning” is more definite evidence that durable goods orders and purchases have turned down, and that consumer goods orders and purchases are at least trending more sideways.

The contradictory signs from initial and continuing jobless claims: what do they mean?

 

 - by New Deal democrat

As I wrote earlier this week, the positive trend in initial jobless claims is one of the most important data points indicating there is no imminent threat of recession. That continues, but what is increasingly disconcerting is the completely contrary signal from continuing claims.

Let’s deal with the weekly numbers first. Initial claims rose 7,000 to 226,000, while the four week average declined -500 to 220,750. Continuing claims, with the typical one week delay, rose 23,000 to 1.974 million, their highest level since mid-November 2021:

As per usual, the YoY% change is more important for forecasting purposes, and so measured, initial claims were lower by -3.4%, and the four week average down -7.8%, while continuing claims were higher by 5.2%:

Since initial claims have historically led the direction of the unemployment rate, here is the update on that metric, plus initial+continued claims, which are more coincident:

Initial claims suggest if anything downward pressure on the unemployment rate in the next several months, while the aggregate initial+continued claims suggest upward pressure in the next jobs report.

There have been other periods in the past 60 years when initial claims improved, but continuing claims remained elevated. To best show this, the below graphs divide the pre-pandemic historical record into two; first, 1966-1992:

And 1993-2019:

The first thing to notice is that initial claims have always led continuing claims, which is why I have paid more attention to them. Second, there have been four extended periods — 1984-85, 1995-96, 2002-03, and 2006-07 — where both measures of jobless claims were substantially higher YoY without a recession occurring. In two of those cases — 1985-86 and 1999 — continuing claims lingered higher for many months after initial claims turned down YoY.

But in no case have initial claims, measured monthly, remained more than 12% higher YoY for at least two full months without a recession occurring. And, to reiterate what I’ve said above, initial claims always led. 

It is possible that we are seeing some of the same seasonal variation this summer which gave rise to the massive downward revisions to the May and June employment reports. If so, this is likely to reverse itself within the next few weeks as the school year gets started. But in the meantime, the positive signal from initial claims remains one of the two most potent signs (the other being stock prices) that are contra to a danger of near term recession.

Dismal scenes from the July employment report

 

 - by New Deal democrat

We’ve settled back in to our typical post-employment week lack of new data, so today is a good day to update the leading indicators from the employment report, especially in view of their important contribution to why I went on “recession watch” yesterday.

As you probably already know, because I harp on it all the time, service sector spending frequently powers right through recessions. It is a downturn in the broad goods-producing sector which is a leading indicator.

In the past few months, there have been a few signs that goods-producing jobs were topping, but they were ambiguous. With the revisions last Friday that ambiguity seems to have been resolved. Below is a graph of employment in manufacturing (gold), total construction (red), residential building construction (orange) and goods-producing as a whole (blue), all normed to 100 as of April with the exception of residential construction, which peaked in March:

Only total construction jobs (including lagging sectors like nonresidential construction) have not turned down, with a 0.1% increase in the past three months. Manufacturing employment and residential construction employment are both down -0.3%. Goods-producing employment as a whole is down -0.2%.

Another leading indicator in the jobs report is the number of short-term unemployed. These are people who have been unemployed less than 5 weeks. This metric is somewhat noisy, but generally accords with initial jobless claims. 

Here is the historical record from 1990 until the Great Recession (unsurprisingly the series did not turn up before the pandemic, which is why I have not included the 2010’s):

Note that while there is considerable month to month noise, on a quarterly basis the signal comes through.

Here is the post-pandemic record:

With the exception of last autumn, there has been a significant uptrend in this metric.

Next let’s take an updated look at real aggregate nonsupervisory payrolls. Recall that this is an excellent “fundamental” indicator, tellling us how much average American working families in total have to spend in real terms. When that turns down, so does spending, and a recession almost always quickly follows. This has been stagnating this year:

Since March there has been only one new high, by 0.1%, in May. On Friday *nominal* aggregate pay was up 0.6%. We won’t have the “real” figure until next Tuesday’s CPI report, but even if CPI is relatively tame, it is unlikely real aggregate payrolls will be higher than May by more than 0.1%, for a 0.2% over four months - which would be a very lackluster increase.

Finally, the one leading indicator in the employment report which did not turn down was the average manufacturing workweek, which held steady at 41.0 hours:

This series has generally tracked with manufacturers’ new orders, which also declined into 2023, but then improved in 2024. This series has been generally steady for the past five months.

In yesterday’s post I noted that the three month averages of both the manufacturing and services surveys from the ISM showed a contraction in new orders for the last three months in a row. So it would not be a surprise if hours worked in manufacturing were to decline as well in coming months. Additionally, I’ve been pounding the fact that residential construction jobs turn down after the number of housing units under construction does — and that metric is currently down about -20%, so I see no reason why those jobs won’t continue to decline.

In other words, all of the leading metrics in the jobs reports that I have been waiting to turn down are presently either flat or have indeed turned down. Hence their contribution to the “recession watch.”

“Recession Watch” instituted for US economy, as economically weighted ISM indexes indicate present contraction

 

 - by New Deal democrat

Two months ago, in response to the new orders components of the economically weighted ISM manufacturing and services indexes, I hoisted a yellow flag “Recession Watch.” That continued last month as well.

This month the economically weighted headline numbers tipped into contraction as well. Together with other negative readings in the goods-producing sector of the economy and flagging if still positive services indicators, the yellow flag now transitions into a red flag “recession watch” for the economy as a whole.

Let’s start with this morning’s crucial report.

According to ISM, in July the services sector of the US economy grew at the lowest increment possible, just 0.1 over the balance point at 50.1. The more leading new orders component also grew just slightly at 50.3.

To recap, because manufacturing is much less important to the economy than in the decades before the Millennium, the economically weighted average of the ISM services index (75%) as well as manufacturing (25%), especially over a three month period (to cut down on noise), has been much more accurate since 2000. 

Starting with new orders, the previous two months came in at 51.3 and 46.4, giving us at three month average of 49.3. As I reported yesterday, the three month average for manufacturing new orders was 47.0. Here are what both look like [Note: all graphs from TradingEconomics.com. Blue is services, gray is manufacturing]:

The three month economically weighted average for new orders is 48.8, indicating contraction, just as it has for the previous two months.

The difference this month is that contraction has spread to the headline numbers as well. The previous two months for the service sector were 50.8 and 49.9, making the three month average 49.1. Yesteday the three month average for the manufacturing sector was 48.5. Here is that graph:

As a result, the economically weighted three month average for the headline indexes is 49.1. This has tipped the entirety of the indexes into not just leading but *present* contraction.

Before I conclude, what happened with the prices paid component is also noteworthy. The prices paid component clocked in at 69.9, a 2.5 year high, as is the three month average. As the below graph shows, the prices paid component of the manufacturing index has also made 3 year highs, although it backed off in July:

In short, what the ISM manufacturing and services indexes together tell us is that we have accelerating inflation, manufacturing contraction, and services just treading water. Or, in other words, stagflation.

Two months ago I concluded with the statement: “In the meantime, watch to see if the remaining short leading indicators to fall into place, most notably new jobless claims, consumer retail spending, employment in the goods-producing sectors, at very least a stalling in aggregate real payroll growth.” With the exception of new jobless claims, all of these have either stalled or contracted.

As I’ve said in the past two months, treat the terms “watch” and “warning” the way you would for weather. A “watch” means that conditions are right, and the economy is at significantly heightened risk of a recession starting in the next few months. A “warning” would mean that a recession is likely, and almost imminently. A “recession watch” for the US economy is now amply justified. Almost the only reason for not upgrading to a “warning” already is the below graph:

With rare exception, before a recession begins stock prices peak and turn down, while initial jobless claims turn up by 10% or more YoY. In addition to the above, I really think we need one more month of data to see if the recent downturn in real consumer spending is just payback for the previous front-running of tariffs, or whether it is a more durable trend. 

But to reiterate, consider this the initiation of a “Recession Watch” for the US economy as a whole.

“Recession watch” for economically weighted ISM indexes, and residential construction spending, continues

 

 - by New Deal democrat



Since Friday featured the very salient jobs report - and its immediate fallout - I delayed reporting on two other important reports that typically start the month - the ISM manufacturing index, and construction spending - until today. As it turns out, they only amplify the message from the employment report that starting in April - remember “Liberation Day”? - the goods producing part of the economy turned down. 

Let me start with the ISM manufacturing report, and repeat my typical opening summary. This metric has been a recognized leading indicator for the past 60+ years, although of diminished importance since the turn of the Millennium (it was in deep contraction both in 2015-16 and again in 2022 without a recession occurring). Any number below 50 indicates contraction. The ISM itself indicates that the number must be 42.5 or less to signal recession. 

Because of the report’s diminished importance, for forecasting purposes, I use an economically weighted three month average of the manufacturing and non-manufacturing indexes, with a 25% and 75% weighting, respectively. Two months ago, and again last month, that average justified a “recession watch.” 

Friday’s report continues the trend. The headline number for July declined -1.0 to 48.0, while the more leading new orders subindex rose 0.7 to 47.1. Here is a look at both the total index (blue) and new orders subindex (god) for the past fifteen years (via Briefing.com):

Note that both remain slightly better than their low points in 2022-23.

Hare the last six months of both the headline (left column) and new orders (right) numbers:

FEB  50.3  48.6

MAR 49.0. 45.2

APR 48.7. 47.2

MAY 48.5. 47.6

JUN. 49.0. 46.4

JUL 48.0.  47.1

The current three month average for the total index is 48.5, and for the new orders subindex 47.0.

As I indicated above, for the economy as a whole the weighted index of manufacturing (25%) and non-manufacturing (75%) indexes is more important. In the non-manufacturing report, the average of the last two months for the headline and new orders numbers has been 50.4 and 48.8, respectively. Pending the ISM report on services tomorrow, the economically weighted headline number is 49.8, and the new orders average is 48.4.

In short, as of now for the third month in a row the new orders average is forecasting economic contraction in the next few months, and has now been joined by the headline index as well. Which means that, as of today, the “recession watch” forecast signal continues 

If anything, that “recession watch” is only amplified further by Friday’s report on June construction spending. 

For the month, total construction spending (blue in the graph below) declined -0.4%,  while residential construction spending (red) declined -0.7%. Nominally, total  residential construction spending has declined every month but one since last August, and is now down -3.6% from its May 2024 peak. Residential construction spending has declined every month but one in the past year, and is down -7.1% since May of last year:

Even though the cost of construction materials (gold) declined -1.6% in June, meaning that in “real” terms both measures rose last month, that has been the only decrease in costs this year, meaning their respective “real” declines from peak are -7.1% and -9.6%:

Two months ago I concluded by writing “Putting this report together with this morning’s other report on manufacturing from ISM, it appears the goods-producing part of the economy as a whole is very slightly contracting. It will be interesting to see if this is reflected in a decline in goods-producing jobs in Friday’s report.” Last month I reiterated that the goods-producing sector of the US economy was in a downturn.

The revisions in Friday’s jobs report only (here’s that phrase again) amplified that further, as goods-producing jobs have declined for three months in a row:

Which makes tomorrow’s ISM services report decisive, if it means the economically weighted average remains in contraction. In that regard, here’s the graph of the past three years of that index:

And here is the same time period for real consumer spending on services:

The two graphs broadly correlate, and since last Thursday’s real increase in services spending was one of the lowest during that period, I am not optimistic.

Bottom line: the “recession watch” continues.

Weekly Indicators for July 28 - August 1 at Seeking Alpha

 

 - by New Deal democrat

My “Weekly Indicators” post is up at Seeking Alpha.

In the middle of writing the post yesterday afternoon, the news broke that T—-p had fired Erika McEntarfer, the Commissioner of the BLS, for the crime of publishing jobs data that he did not like. For the moment, she has been replaced by her deputy, a civil servant. But even so, going forward data from the BLS is going to have to be treated as suspect. For reliable economic data, this is a “Reichstag fire” moment.

Fortunately, as first became important about 10 years ago when a government shutdown temporarily stopped the production of most Federal data, almost all of the data contained in these “Weekly Indicator” posts comes from other sources — some private, some ultimately from the States, and some from the Fed and its regional banks. None of these are going to be immune to political pressure either, but they are going to be increasingly important as a check on the official data.

Interestingly, as of now they diverge somewhat sharply from the very downbeat monthly data we have seen from a number of reports, and in particular the personal income and spending report Thursday, and the jobs report Friday. Much of this is due to the continued optimism evident in the stock market, a derivative of which is the cashing in of stock options which is helping buoy withholding tax payments; and the lack of layoffs evident in the weekly jobless claims data. But additionally there is no evidence yet of consumers pulling back on spending.

In any event, clicking over and reading will as usual bring you up to the virtual moment as to the state of the economy, and reward me with a penny or two for collecting and collating it for you.

A note on ISM manufacturing and construction spending

 

 - by New Deal democrat

I don’t have time to write a complete report on the ISM manufacturing index for July, and the construction spending report for June, both of which were reported this morning, so I will do that Monday when the ISM services report also comes out.

In the meantime, here is this bullet point summary.

Both reports were negative.

The headline ISM number, 48.0 and the new orders number, 47.0, were contractionary. Additionally, the three month average for both the headline and new orders portions declined further into contraction.

Both the headline and residential components of nominal construction spending declined. In the case of residential spending, it was the 11th decline in the past 12 months. Even without taking inflation into account, residential construction spending is down -7.1% from that peak. 

If the ISM services numbers on Monday are weak enough, that will almost certainly be enough for me to go on “recession watch.”

July jobs report: especially with revisions, an awful report that screams near-recession

 

 - by New Deal democrat

Let me cut right to the chase in this first sentence: the only reason this employment report was not recessionary is that it did not have a negative number. Aside from that, it was either  flat to awful almost across the board.



Put another way, even before the utter chaos of the new Administration in Washington, my focus had been on whether the economy would have a “soft” or “hard” landing, i.e., recession. This report, especially with the revisions to the last two months, virtually screams “Hard Landing!!!”

Below is my in depth synopsis.

HEADLINES:

• 73,000 jobs added. Private sector jobs increased 83,000. Government jobs declined -10,000. The three month average declined sharply to +32,000, well below the breakeven point necessary with any kind of population growth.
• Within government jobs, Federal jobs declined -12,000, while State jobs increased 5,000 and local jobs declined -3,000.
• The pattern of downward revisions to previous months went thermonuclear this month. May was revised downward by -144,000 to only +19,000, and June by -133,000 to only +14,000, for a net decline of -258,000. 
• The alternate, and more volatile measure in the household report, declined by -260,000 jobs. On a YoY basis, this series increased 1,887,000 jobs, or an average of 157,000 monthly.
• The U3 unemployment rate rose 0.1% to 4.2%. Despite this, the real time “Sahm rule”indicator is only at +0.1%, meaning it has not been triggered.
• The U6 underemployment rate rose 0.2% to 7.9%, down -0.1% from its 3+year high in February.
• Further out on the spectrum, those who are not in the labor force but want a job now rose by 145,,000 to 6.175 million, its highest level since July 2021.

Leading employment indicators of a slowdown or recession

These are leading sectors for the economy overall, and help us gauge how much the post-pandemic employment boom is shading towards a downturn. This month they were sharply negative:

• the average manufacturing workweek, one of the 10 components of the Index of Leading Indicators, was unchanged at 41.0 hours, but remains down -0.6 hours from its 2021 peak of 41.6 hours.

• Manufacturing jobs decreased by -11,000, the third decline in a row. This series declined sharply in the second half of 2024 before stabilizing earlier this year. It is now at a 3+ year low.
• Truck driving, which had briefly rebounded, declined another -3,600.
• Construction jobs rose 2,000.
• Residential construction jobs, which are even more leading, declined -1,400. Further, with revisions this is the 4th decline in a row for this important series.
• Goods producing jobs as a whole declined -13,000. With revisions, this is now the third decline in a row, which is very important because these jobs typically decline before any recession occurs. Further, on a YoY% basis, these jobs are now negative by -0.1%. Only three times in the past 70+ years - 1952, 1967, and 1984 - has this series been negative YoY without it being during or shortly before a recession. 

• Temporary jobs, which have declined by over -650,000 since late 2022, declined again this month, by -4,400, close to their post-pandemic low set last October.
• the number of people unemployed for 5 weeks or fewer rose 58,000 to 2,299,000, vs. its 12 month high of 2,465,000 last August.

Wages of non-managerial workers 

• Average Hourly Earnings for Production and Nonsupervisory Personnel increased $.08, or +0.3%, to $31.34, for a YoY gain of just under +3.9%, its lowest YoY% gain in 4 years. Nevertheless, this continues to be well above the 2.7% YoY inflation rate as of last month.

Aggregate hours and wages: 

• The index of aggregate hours worked for non-managerial workers rose 0.3%, and is up 1.1% YoY, about average for the past three years.

• The index of aggregate payrolls for non-managerial workers rose 0.6%, rebounding sharply from last month’s initially reported -0.2%, which has been revised to +0.1%. It is now up 5.0% YoY. 

Other significant data:

• Professional and business employment declined another -14,000. These tend to be well-paying jobs. This is the third decline in a row, and is the lowest since its May 2023 peak except for October 2024. It remains lower YoY by -0.3%, which in the past 80+ years - until now - has almost *always* meant recession. This is vs. last spring when it was down -0.9% YoY.
• The employment population ratio declined -0.1% to 59.6%, vs. 61.1% in February 2020.
• The Labor Force Participation Rate also declined -0.1% to 62.2%, vs. 63.4% in February 2020.

SUMMARY

This was a horrible report. About the only “good” thing to say about it was that the headline number was not actually negative.

There were a few rays of light. Wages and payrolls continued to rise at a good pace, and in particular it is all but certain that real aggregate nonsupervisory payrolls made another new all-time high last month, which is an excellent short leading indicator for continued economic growth. And total construction jobs rose slightly, although that was in the more lagging public sector.

But aside from the aforementioned aggregate payrolls, and the manufacturing workweek which was steady, all of other, important leading indicators in the report declined. Perhaps most importantly, residential construction jobs appear to have at long last decisively turned down. This is typically one of the last shoes to drop in that sector before a recession begins. And more broadly, goods producing jobs as a whole - again, with revisions - also appear to have made a significant downward turn.

In the previous two months, the only reason the unemployment and underemployment rates did not go up was that the labor force participation declined significantly. This month their luck ran out as, even with another LFPR decline, both unemployment and underemployment went up. And once again, further out on the spectrum, those not in the labor force but who want a job increased to the highest level in 4 years.

Last month I concluded that “Indeed, if construction jobs had turned down, this report would probably have merited going on ‘recession watch.’ We’re not quite there, but we’re not far away either.” Yesterday I wrote that real personal income and spending merited a “yellow flag” and would have warranted a “recession watch” but for the tariff front-running issue. With this morning’s report, we are now a hair’s breadth away from “recesion watch.” The only reason not to hoist a red flag now is that I still want to see the ISM manufacturing and services reports for July.

June personal income and spending: very weak as payback for front-running continues, meriting a yellow flag

 

 - by New Deal democrat

In my conclusion last month, I wrote “In the first two months of Q2, total real spending has declined by -0.8%, while services has been basically unchanged. If there is a further decline in June, based on the above discussion that would likely trigger a “recession watch” signal.”

To cut to the chase, June’s report just barely missed giving that signal. If it weren’t for the fact that so much of the weakness is obvious payback for the front-running in March and April, it would be a serious concern. Even so, it’s worth hoisting a yellow flag caution, while unfortunately waiting one more month to see if the weakness persists.

Let’s go to the data. With the exception of the personal saving rate, and one YoY graph, all of the data in the below graphs is normed to 100 as of just before the pandemic.

To begin with, nominally income and spending both rose 0.3%. After accounting for inflation, which also rose 0.3%, real income was flat and real spending rounded to 0.1% higher:

Since real spending on goods rarely turns down, even in recessions, the focus is on goods. In that regard, real spending on both goods and services rose 0.1% in June:

Additionally, there is authority for the fact that spending on durable goods usually cools risk before spending on non-durable goods. In June, the former declined -0.5%, while the latter rose 0.4%:

Real spending on durable goods has declined for three months in a row, and is down -2.5% since March.

In case you haven’t noticed already, a common thread in almost all of the above data is that it has been virtually flat, or worse, since March. As I indicated above, normally that would warrant at least a recession watch; but this year, so far it is consistent with front-running tariffs in March and April, with payback in May and June.

Next, here is the personal savings rate. I follow this because just before and going into recessions it tends to turn up as consumers get more cautious. In June it remained steady at 4.5%, in line with its typical reading this year, although higher than last autumn:

Before I conclude with two final data sets, one way to differentiate between noise and trend is to look at the YoY comparisons.In general while real income and spending do not turn negative YoY until after a recession has started, usually they have declined 50% or more from their YoY peaks within the previous 12 months (e.g. a decline from up 4.0% YoY to being up 2.0% YoY). Bleow are real income (gray), real spending (dark blue), real spending on durables (red), and real spending on services (gold), normed to their YoY high comparisons:

So measured, tow of the above data series are close to that threshold: real spending is down -33.8% from its YoY high, and real spending on services is down -47.3%. Real spending on durable goods has actually crossed the threshold, down -52.8%. Only real income, down -25.7% is nowhere near the threshold.

Finally, let’s take a look at two coincident indicators from this report which the NBER pays close attention to in dating recessions. First, here is real income less government transfers:

This declined -0.2% for the second decline in a row. Since one year ago, this metric was higher by 2.8% YoY, and is now only higher 1.2% YoY, at -55.4% it has also crossed the 50% decline threshold I mentioned above.

Second, here is real manufacturing and trade industries sales, which is delayed one month and so if for May:

This also declined, by -0.3%, also for the second decline in a row, although note that the overall trend since mid-2022 remains higher.

Last month, looking at historical trends I noted that “real spending on services rarely turns down, even during recessions, although usually its growth does declerate below 1% annualized during the quarter just preceding or starting the recession.” Further, where real spending on goods declined -1% YoY or more, about 50% of the time that also signaled recession (vs. slowdown the other 50%). And “If growth in real spending on services was also [i.e., simultaneously] decelerating sharply, even if still positive, it almost always meant recession.” 

Real spending on goods is still higher by 2.9% YoY, so we are not near this signal.

Let me put this all together. This was a very weak report, although not negative. If there were not distortions from the front-running of tariffs earlier this year, it would come very close to meriting a “recession watch.”  But by next month, the payback from this previous front-running should have largely abated. If there is a rebound, needless to say that will be good. But if the weakness persists, we may cross the threshold. As it is, because of this uncertainty a “yellow flag” caution, ie., pay extra close attention, is merited.

The bottom line in Q2 GDP; front-running, payback, and contrasting long leading indicators

 

 - by New Deal democrat

Today’s GDP report for Q2 was pretty much as we expected, i.e., payback from the front-running of import tariffs in Q1. But as usual, my main focus is on the two long leading components.

The headline was a 3.0% annualized increase in real GDP, rebounding from the -0.5% decrease in Q1 (blue in the graph below). But “core” GDP, i.e., real final sales to domestic purchasers, tells a somewhat different story, decelerating from 1.9% annualized in Q1 to 1.2% in Q2 (red):

In fact “core” GDP growth, while positive, was the lowest since the end of 2022. But again, we know that consumers accelerated some purchases into Q1 that they otherwise would have done in Q2 or even later, so this deceleration is also somewhat misleading.

Now let’s look at the impact of tariffs. Producers and wholesalers in the US ran up their inventories in Q1 in anticipation of the increased tariffs, meaning there was likely to be payback in Q2. And there was (blue in the graph below), as inventories declined -5.8% on an annualized basis. Which unsurprisingly is in accord with the fact that after rising in Q1, imports fell -8.8% (red). If there was a surprise at all, it was that exports declined in Q2 as well, by -4.4% annualized, after increasing 1.0% in Q1 (gold):

So the headline takeaway for me is slowing growth in Q2 with a decline in exports (which of course is not supposed to happen in the Tariffistas’ utopia).

Now let’s look at the two long leading components of GDP.

First, in accord with the recessionary housing data that I have been writing about each month, both nominal (blue) and real (red) private residential investment in Q2 declined, by -3.2% and -4.6% annualized, respectively:

Note that this is the second quarterly decline in a row in real terms.

Here is the longer term view, showing that housing tends to turn down more than a year before th economy as a whole:

If housing was negative, proprietors’ income (blue), which is a proxy for corporate profits (red) (which won’t be reported for another month) was positive, increasing 3.4% annualized on a nominal basis. Even after taking into account the GDP deflator, which increased at a 2.0% annualized rate, business income was positive.:

This is of a piece with what has been reported on Wall Street for Q2 so far.

Even without the complicating picture from tariffs, the background long leading indicators remain mixed, with elevated but rangebound interest rates and term spreads, increasing real money supply, and mixed real consumer spending on goods, in addition to the negative housing impacts but continuing positive profits.

I anticipate the combined impact of tariffs and the recent tax bill to negatively impact the economy as a whole, as higher prices for consumers and cutbacks in benefits more than counterbalance the tax giveaways to the wealthy. But the Q2 GDP report shows no significant effects on the bottom line yet.