27 Jan 2023 3 min read

False signals or false dawns?

By Tim Drayson

Recent US GDP data have bolstered the case for an economic soft landing, but survey figures suggest something more sinister lies ahead.


Economists typically use two consecutive negative quarters of GDP growth to determine the threshold for recession. On this basis, the US was far from recession in the second half of last year. Economic expansion of 3% is about double its trend rate of growth, which would keep unemployment steady.

In theory, GDP captures the entire output of an economy, but in practice it is still a sample and can be erratic on a quarterly basis as statisticians struggle to reconcile differences between output, expenditure and income flows. It is also prone to multiple revisions.

Eventually, I expect the first half of 2022 to be revised up from its current contraction, which is at odds with the incredibly strong employment data and robust survey evidence over this period.

Even if accurately measured, GDP is also a lagging indicator, both in terms of when the data are published (we only received the first estimate of fourth-quarter GDP at the end of January) and how they is calculated. Monthly retail sales and industrial production suggest the US lost momentum through the final quarter of 2022, but this is not captured in the quarterly average growth rate, which is influenced more by what happened at the end of the previous quarter.


Surveys suggest recession

The surveys are consistent with the US already being in recession. Business and consumer confidence, purchasing manager indices and housing market indicators are already at low levels. Some of them have been weak for a few months.

Surveys are more forward-looking than GDP, but are also driven by sentiment.

The surge in inflation and subsequent aggressive response from the Federal Reserve (Fed) have heightened concern around recession and might have pushed these surveys down.

Beware the bias

There are three other biases worth considering. First, surveys are diffusion indices, so in contrast to GDP, do not capture the magnitude of any change. They will tend to overstate output when some sectors are experiencing steep falls and understate output if the output losses are small but more evenly spread, alongside some sectors still doing very well.

Second, business respondents can be confused about price changes. Recently we have seen some reversal of earlier pandemic-induced price spikes in manufactured goods. This might be perceived as a fall in revenues when real output is holding up just fine.

Finally, some surveys appear to reflect the political environment. For example, the National Federation of Small Businesses survey reads consistently higher under a Republican President than a Democrat.


The signs aren’t good

But the breadth of pessimism among the surveys is our main concern, particularly in the most forward-looking components such as new orders.

We also have a central bank determined to clamp down on demand to cool an overheated labour market and well-above-target inflation. We can cross check with the Fed’s Beige Book, which has a good track record of reflecting current economic conditions. This contains a range of anecdotes about the business situation across all regions and sectors of the economy. This has shown a steady deceleration in the pace of growth through 2022 and indicated that the economy stalled around the turn of the year.

Over the next couple of quarters and amid a challenging global backdrop we expect US GDP to begin to reflect the signal from the surveys. Despite the positive start to the year, we expect risk assets to react negatively as the recession develops.

Tim Drayson

Head of Economics

Tim keeps a close watch on global economic developments, with a particular focus on the US. He believes nothing good ever happens after midnight, which is why he is rarely spotted out late. Tim joined in 2008 from the number-one ranked economics team at ABN AMRO, with prior experience from HM Treasury, and graduated with a MSc from the University of Nottingham. When not crunching economic data, he can be found studying the weather forecast, analysing his cycling statistics or looking anxious on three-foot putts.

Tim Drayson