Friday’s weak real PCE data have triggered abrupt downward revisions to estimated GDP growth during the first quarter and associated rise in the perceived (next-12-months) recession risk. I took my own best guess of real PCE growth from 1 ½% (ar) to ¼%, which alone would have been worth almost about a percentage point off the estimated GDP growth rate.
I don’t typically try to guess the GDP growth rate, because it tends to be a noisy measure of underlying demand growth. But I figured that with a plausible amount of drag from trade (and a plausible offset from inventories), we could easily rationalize a GDP estimate in the range of 0 to 1%. In the event, the more sober analysts seem to have gone to the lower end of that range.
The Atlanta Fed is currently at -0.5% on their “alternative” measure, which should really be their main measure because it corrects for the non-monetary gold issue, around which there is not really much dispute. (They may lower this a bit further in response to the ISM, particularly the weak detail there.) But even their corrected measure assumes that the sum of the drag from trade and the very minor offset from inventories cuts GDP growth by 210 basis points. That seems extreme in an environment of weak final domestic demand growth, so the consensus is hesitant to join them there, rote interpretation of the data flow aside.
Anyhow, it is now a near call whether the Q1 GDP growth rate will be positive or negative. And while many of us try not to be too affected by the GDP bean count, the prospect of a negative quarter has obviously concentrated minds. And I notice some analysts are reacting by placing a bit more emphasis on the soft data, which have also been weak.
My own take is as follows. The economy does not appear to be in recession now, partly because of the state of the labor market and the income flows associated with that. Having said that, for the past couple months, it has seemed obvious that demand growth has downshifted, just not into recession, and last month’s employment report was fully consistentwith that take, although the consensus was that it was strong.
My priors point away from recession, mainly because there are no major real imbalances in the economy. But we probably need to put a little more emphasis on data watching – and not lean excessively on those priors – because this political backdrop is unprecedented in modern American history. (Maybe the late 1850s might compare, but that is not my thing.) So, as the weaker data have flowed in, it has been appropriate to darken the perspective on even the short-term outlook.
The absence of major real imbalances in the economy has suggested that if weakness were to begin to accumulate, then the Fed could ease into that before it turned into something major, so long as Trump did not choose the wrong course on tariffs. Another way to put this was that running a heightened medium-term recession risk would be a policy choice. A nice reduction of this was: tariff heavy = recession risk and tariff light = no recession.
But time has moved on, and the news has come in. And now we are in an awkward situation in the sense that Trump may be about to announce a policy change that will deliver a direct hit to aggregate demand at the same time as an impetus to underlying inflation. That would further raise the recession risk even if the announcement were taken seriously as the final word and uncertainty were lifted a bit.
There is also the chance that Trump again decides to introduce a further delay along with further uncertainty. That would beat actually going tariff heavy. And such a trick might have been tolerable as an improvement over actually following through a couple months ago, when demand conditions looked stronger. But in the current environment it might not work, because it would risk leaving the economy in its weakened state at a time when the Fed will delay easing to offset the weakness.
To some extent, the Fed’s own weird aversion to changes in the directional path of policy is imposing an unnecessary constraint here. In a better world, the Fed might ease into the weakness and then insist it would reverse the ease if Trump actually delivered the inflation impulse. Sure, that is politically implausible. I get it. But that is the point. The politics make it awkward here, in part because of what the Fed has set up as their standard operation, which involves an aversion to directional changes in the path of the funds rate. Recognizing the odd politics here, in the Administration and at the Fed, might help resolve what might otherwise seem dissonant.
