GDP Print at 2.6 Percent Is Largely From Inventory/Exports Anomaly

The anomaly we predicted in the first quarter has been realized

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Commentary

GDP printed at 2.6 percent Thursday morning, just slightly above the consensus estimate of 2.4 percent. I had estimated the GDP to print at 2 percent, plus or minus 0.5 percent in my September jobs report.

As we predicted, the current positive report is largely attributable to a reversal of an anomaly with imports clearing the ports that we saw in 2022Q1 and Q2. That anomaly cleared in 2022Q3, so that net exports (NEX), which are a deduction from GDP became an addition to GDP because a reduction in imports caused the figure to go positive (subtracting a negative yields a positive.)

The Bureau of Economic Analysis (BEA) print turned the economy from a technical recession, which most analysts accept as the two consecutive quarters of negative growth we saw in 2022Q1 and Q2, into growth.

The Data Charts

2022 Q3 Summary GDP by Major Category PCE = Personal Consumption Expenditures, GDI = Gross Domestic Investments, NEX = Net Exports, GCE= Government Consumption Expenditures

We see that the overwhelming portion of GDP growth was courtesy of the export anomaly we had identified back in our 2022Q1 GDP report as imports clearing the ports that had been backlogged. Our operating thesis was that inventories that had been back-ordered filled store shelves after clearing U.S. ports in 2022Q1. That timing difference has now largely normalized so that the change in imports became turned negative and thus a net addition to GDP (i.e., subtracting a negative becomes a positive.)

2022Q3 Net Exports

Federal Reserve Meeting

The Fed meets next week, but there is no expectation they will change off its path to boost interest rates by 75 basis points as they will not be producing the “dot plot” estimates of the economy that concerned us last month. We anticipate the 75 bps rate hike.

As we said last quarter, which has largely been proven true:

The markets seem to be sensing that the Fed will pivot, first to lower increases 50 or 25 bps and then, eventually, lower rates again. Our view is such a sentiment is hope over experience. Barring political considerations (which can never be discounted in the purportedly “independent” Fed) we believe the central bank will continue hikes until we return to a normalizing economy and a return to r* (r-star), the natural rate of interest, plus at least 100 basis points. We believe the “burn-off” of the Fed balance sheet that commenced in June and that will accelerate to $95 billion in September, barring unforeseen circumstances, will tighten markets and put the financial markets and the economy into further decline. Especially hard hit will be multinational companies with extensive foreign markets and translation risks. (We saw that already with some of the reporting earlier this month.)

While the export anomaly avoided the continuation of the technical recession, we believe it to be merely a temporary reprieve. We think 2023Q3 will be revised downward in the second and third prints, closer to our 2 percent baseline we predicted in September.

We think the chance of recession in Q4 is now 4 in 10. But 2023 is more negative, with a negative GDP print by the end of that calendar year. That view was reinforced Thursday morning when the 3-month “short money” and the 10-year “long money” yield curve inverted, so that the former paid a higher rate of interest than the latter.

Such an inversion tends to signal that investors are uncertain and have diminished faith in the economy. So, instead of investing in businesses, they invest in “sure thing” shorter-term Treasuries, pushing down rates and inverting the curve. (The 2 year/10 year Treasury has been inverted for some time.)

We continue to be troubled by the prospect of so-called “zombie” loans arising from the Fed’s low-interest rates since 2008. Most of those concerns are around commercial real estate construction and purchase loans. We project that office buildings in a newly evolved remote work economy will be difficult to fill and that many of the construction and purchase mortgages used to build or acquire such properties will default. That, in turn, will result in an additional and more severe slowdown, particularly in the regional banking sector.

Finally, we see Europe slowing down considerably as the European Central Bank doubled rates from 0.75 percent to 1.5 percent on Thursday morning.

Looking Forward

We think 2022Q4 GDP will print in the range of 1 percent. (We revise our forecast in our monthly jobs reports and, when necessary, our @stuysquare Twitter feed if and as exigent circumstances warrant.)

There are numerous grey or black swans on the horizon that should concern investors. The most obvious is the Ukraine War spinning further out of control with ongoing threats of a dirty bomb or a tactical nuclear bomb being deployed. Investors should monitor that situation closely as markets can turn on a dime if the war escalates. China’s belligerence is ongoing and enhanced by the 20th Party Congress extending Xi Jinping another 5-year term.

Food inflation will continue, although gas and fuel prices will come down after the winter surge as the economy will likely be in a fairly severe recession. Housing will continue to slow down as will the banking sectors that finance the industry

Any one of these off-white “swans” could markedly alter the outlook for the economy, as could a new virulent variant of the CCP virus, commonly referenced as “COVID-19.”

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DISCLOSURE: The views expressed, including the outcome of future events, are the opinions of the firm and its management only as of October 27, 2022, and will not be revised for events after this document is submitted to The Epoch Times editors for publication. Statements herein do not represent, and should not be considered to be, investment advice. You should not use this article for that purpose. This article includes forward-looking statements as to future events that may or may not develop as the writer opines. Before making any investment decision you should consult your own investment, business, legal, tax, and financial advisers. We associate with principals of TechnoMetrica on survey work in some elements of our business.

Note: Our commentaries most often tend to be event-driven. They are mostly written from a public policy, economic, or political/geopolitical perspective. Some are written from a management consulting perspective for companies that we believe to be underperforming and include strategies that we would recommend were the companies our clients.