Why the Latest GDP Numbers May Not Be What They Seem

Brent Schutte, CFA, is chief investment officer of the Northwestern Mutual Wealth Management Company.

Seemingly robust consumer spending and stronger than expected inflation readings in last week’s gross domestic product (GDP) release had some market watchers once again contemplating a return of stagflation last seen in the late 1970s through early 1980s. Yet a closer look at the data, along with some context provided by the past several months of individual economic readings, highlights how one or two outliers can obscure the larger picture.

While the headline GDP reading of 1.1 percent growth for the quarter fell well shy of the 2 percent consensus forecast, some market watchers were quick to highlight that personal consumption came in at a 3.7 percent annualized rate and cited the reading as evidence that the economy remained resilient despite the Federal Reserve’s efforts to quell demand through raising rates. However, the seemingly strong number may not be as robust as it initially appears. A look at monthly data that feeds into the quarterly GDP shows that, with the exception of the unseasonably warm month of January, consumer spending has been mostly flat or declining over the past five months. From November through March, total personal consumption was flat or negative in three of the past five months, up just 0.1 percent in February but up a significant 2 percent in January. When looking at inflation-adjusted numbers, the trend is even more striking, with real growth registering declines in three months and a flat reading in March but a jump of 1.4 percent in January. Simply put, absent the January spike, consumer spending would have come in far lower.

Overall GDP is now up 1.6 percent year over year compared with 0.9 percent year over year at the end of 2022. However, the latest 12-month reading is less than half the 3.7 percent 12-month pace registered in March 2022 and well below the 2.6 percent rate recorded at the end of 2019, just prior to the arrival of COVID.

A similar trend can be seen in the inflation data as measured by the Personal Consumption Expenditures (PCE) data. On a seasonally adjusted annualized basis, headline PCE was running at 4.2 percent year over year compared to 5.1 in February, while core PCE, which excludes volatile food and gas prices, came in at 4.6 percent—down from last month’s level of 4.7 percent. But as with personal consumption, January has a distorting effect on the overall reading, with both headline and core readings jumping by 0.6 percent that month.

We are not suggesting that January’s data is flawed but rather that it is an outlier that is clouding the overall trend of a slowing economy and declining inflation. Despite the trajectory lower, we believe the Federal Reserve will still raise rates 25 basis points during its meeting this week because it remains concerned that despite some fraying, the still resilient employment picture needs to soften further before the threat of an inflation resurgence is fully extinguished. This stance, in our view, will unfortunately push the slowing economy into contraction and lead to a short, mild recession in the quarters ahead.

Wall Street Wrap

Liquidity continues to dry up: Data out last week from the Federal Reserve shows that liquidity in the U.S. economy is subsiding, with the M2 money supply (which includes cash, checking accounts, bank deposits and other highly liquid sources of money) shrinking by a near record 4.1 percent in March. We’ve noted the decline in money supply periodically over the past several months and have highlighted the correlation between the historic infusion of liquidity into the economy through fiscal and monetary policy in response to COVID and the dramatic spike in inflation. We also showed that the so-called M2 money supply, which grew at a record 26.9 percent in February 2021, was dramatically declining, and we believed it would lead to lower inflation going forward. While the economy has yet to fully work off the spike in supply that flowed into the economy during the height of COVID, the steady, steep decline in new liquidity will likely have meaningful implications for inflation and growth going forward. With fewer dollars to chase goods, services and investment opportunities, demand will become increasingly constrained, making it more difficult for manufacturers and service suppliers to increase prices. Similarly, less money for investment will likely translate to fewer expansion opportunities being funded, which will likely result in slowing or declining growth. A look at history highlights this relationship.

Since 1900, there have been three other periods during which money supply decreased; 1921, 1930–33 and 1958. During each of these periods the economy found itself in recession. While we don’t foresee that the recent draining of liquidity will result in a repeat of the type of recession experienced in the 1930s, we believe that the reduced money supply, along with tightening lending standards from the banking industry, will act as a drag in the economy (and inflation) during the coming quarters.

A sour outlook for the future: The Conference Board Consumer Confidence Index declined in April. The Index now stands at 101.3, down from March’s level of 104. However, the report showed that consumer views of the current economic climate were modestly less pessimistic, with respondents viewing business conditions as bad falling to 18.1 percent, down from the March reading of 19.3 percent. Those describing current conditions as good were unchanged at 18.8 percent. However, expectations for future conditions fell to a reading of 68.1 from the prior month’s level of 74. The authors of the report note that the latest reading once again coincided with levels that typically are reached during recessions. The deterioration in expectations was particularly sharp among those under 55 years old and households earning $50,000 or more annually.

The income differential (those who expect higher wages less those expecting lower wages over the next six months) came in at 4.1 percent—well off the recent high of 11.6 percent registered in June 2021. For further context, this income differential was 16.6 percent just prior to the arrival of COVID. The subdued wage expectations come despite consumers feeling slightly more optimistic about their job prospects, as measured by the labor differential reading. The differential is a measure of the gap between the number of respondents who believe jobs are easy to land and those who report challenges finding work. The measure ticked up to 37.3 in April from 36.5 in March. For context, the labor differential was at 47.1 in March 2022.

Inflation expectations remain unchanged, with consumers anticipating prices will rise 6.2 percent in the coming year. While still elevated, the reading is down sharply from a peak of 7.9 percent registered last year, and, importantly, the expectation of higher prices does not appear to be prompting consumers to buy ahead of price increases. The release accompanying the data noted that purchasing plans for big-ticket items like homes, cars and appliances as well as vacations all fell during April.

Housing shows signs of moderating: The latest S&P CoreLogic Case-Shiller Index shows prices in February rose modestly, up 0.2 percent from the prior month, breaking a streak of seven consecutive months of declines. February’s reading indicates home prices rose 2 percent year over year, down from January’s year-over-year gain of 3.7 percent and well below the recent peak of 20.8 percent registered in March of 2022.

The survey’s 20-city composite indicates home prices rose just 0.4 percent year over year, down from the prior month’s rate of 2.6 percent. The continued easing of home price appreciation is noteworthy given that shelter has a significant weight in the calculation of the Consumer Price Index (CPI), with price movements taking 12 months or longer to begin to affect the CPI reading. With shelter costs having peaked in the first quarter of 2022, we expect this portion of the CPI calculation should fall significantly in the coming months.

Economy treading water: The Chicago Federal Reserve’s National Activity report—a measure of 85 monthly economic indicators to measure U.S. economic activity—showed contraction with a reading of -0.19 for March, unchanged from the prior month. Readings above zero indicate above trend growth, while readings below zero are interpreted as a sign of contraction. While the measure has shown some stability of late, we believe the current plateau could evaporate should the fed continue to raise rates at a time when financial institutions are tightening their lending standards.

Jobless claims edge lower: Weekly jobless claims moved lower last week with 230,000 new claims filed, up from the prior adjusted reading of 246,000. Continuing claims (those people remaining on unemployment benefits) remain elevated at 1.815 million.

The week ahead

Monday: The Institute of Supply Management (ISM) will release its latest Purchasing Managers Manufacturing Index for April. Recent readings have shown the manufacturing sector in contraction as demand subsides and supply normalizes. The ISM services report will be released on Wednesday, and we’ll review these reports to help determine overall economic strength.

Tuesday: The Bureau of Labor Statistics releases its Job Openings and Labor Turnover Survey report for March. February’s report showed job openings edging lower. We’ll be watching for any indications that the gap between job openings and job seekers is narrowing further, which may help ease wage pressure for businesses.

Wednesday: The Federal Reserve will be in the spotlight as it releases its statement following its monthly meeting. We expect a hike of 25 basis points and will be watching for signs the Fed is ready to press pause on its now year-long rate hiking cycle.

Thursday: Initial and continuing jobless claims will be announced before the market opens. Initial filings declined last week, and we will be watching to see if recent signs of some softening in the job market resume.

Friday: The Bureau of Labor Statistics will release the April Jobs report. In prior editions we’ve noted that a significant gap has emerged between the Nonfarm Payrolls report and the Household report. We’ll continue to watch for signs that this gap is narrowing as well as any changes in hourly earnings for workers to help gauge whether wage growth has continued to recede.

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