On Thursday 25th August, the US Bureau of Economic Analysis (BEA) put out the second estimate of its GDP for the second quarter ended June 2022. According to the second estimate put out by the BEA, the US Real GDP contracted by -0.6% in the June quarter. This is lower than the preliminary estimate of -0.9% contraction that the BEA had put out earlier.
However, the second estimate is normally more reliable since it considers more data points with updated data flows. The moral of the story is that the US economy has still contracted in the second quarter ended June, although the contraction is less than estimated. In the first quarter ended March 2022, the US Real GDP had contracted by -1.6%, so this represents the second consecutive quarter of real GDP contraction for the US economy.
Key drivers of Q2 GDP in the US economy
What exactly triggered this lower real GDP in the June 2022 quarter? The decrease in real GDP was largely on account of lower private inventory investment, weak residential fixed investment and lower spending by the federal government as well as by the local and state governments. Let us now look at each of these components of the GDP basket. The fall in private inventory investment was triggered by lower retail trade. On the other hand, the lower federal government spending was triggered by a fall in non-defence spending, even as defence spending was actually higher. The sale of crude oil from the Strategic Petroleum Reserve (SPR) was the main item contributing to lower non-defence spending. Higher imports in the quarter were largely triggered by the demand for travel services.
Now, for the positive triggers to the GDP, which partially offset the above negative triggers. The growth pressures were offset by an increase in exports and a surge in consumer spending. On the exports front, there was a perceptible increase in exports of industrial supplies and materials. Export of travel services were also higher. The other mitigating item was the surge in consumer spending, which largely reflected the surge in demand for food and accommodation services. Due to these mitigating factors; the eventual contraction in GDP for the June 2022 quarter came in at -0.6%. This is 30 bps lower than the first estimate of -0.9% for Q2 and 100 bps lower than the Q1 Real GDP contraction of -1.6%.
Beyond Real GDP; some key parameters to look at
Real GDP contraction by -0.6% only tells you part of the story and that is something the US policymakers have been harping on time and again. It would make sense to look at some of the other key parameters to understand Real GDP story in the proper perspective.
The current dollar GDP (nominal GDP) was up 8.4%, indicating annualized nominal GDP of $24.88 trillion for the full year based on Q2 estimates. That is nearly $31 billion higher than the previous estimate. Why is the Real GDP negative despite the nominal GDP being positive. The reason is the high inflation levels, since real GDP is net of inflation. Which is why a lot of the Real GDP story will predicate on inflation control from here.
The PCE inflation, which the Fed considers for its rate trajectory has been static at 7.1% in Q2 while the core PCE has been also static at 4.4% in Q2. In short, from a consumption perspective, inflation is not really showing signs of tapering meaningfully.
This will matter from a policy perspective. The current-dollar personal income increased by $353 billion in Q2, at par with the previous estimates. The loosening of purse strings post COVID is still having a lag effect and till that tapers, inflation is unlikely to come down meaningfully. Even disposable incomes are up by 6.5% in Q2.
Corporate profits for Q2 adjusted for inventory valuation and capital consumption was up $175.2 billion in Q2, compared to a fall of $63.8 billion in Q1. Even the financial institutions saw a spike in profits compared to a fall in the previous quarter.
The gist of the US story is that the preconditions for inflation control are still missing.
What does this mean for US Fed policy?
The Q2 GDP data will obviously weigh on the mind of Jerome Powell when he makes his speech over the weekend at Jackson Hole Symposium at Wyoming. Even ahead of the GDP data, the Fed had already hinted that their key decision point would still be inflation and that is still too high by historical standards.
With the GDP contraction for Q2 being lower than the first estimate it would only support the claim of the Fed that front loading of rate hikes must be the priority of the central bank. While we still await the finer details coming from Powell’s speech at Jackson Hole, it looks unlikely that the Fed would relent on rate hikes any time soon. The hawkish undertone is likely to stay, at least, through the next 3 Fed policy meets in year 2022.
What does the US GDP number mean for India?
Let us start with the good news. In the last few days we have seen a lot of disconcerting statements about the IT industry cutting down on bonuses, variable pay etc. This was on fears that the US and European customers may squeeze on margins. Now the only missing link in the US story is inflation control and if that happens, even real GDP should look up. That means, the impact on IT spending would only be marginal and that is good news for Indian IT companies. Europe may still put some pricing pressure.
However, if the US is unwilling to relent on rate hikes, it would mean that the RBI would also prepare for a terminal repo rate of 6.5% instead of the current 5.4%. RBI hawkishness may be more sober in the coming policy statements. However, the RBI is unlikely to relent on raising rates higher from current levels. Like in the US, the best that the central bank can do in India is to curb inflation to give an automatic boost to real GDP growth.