The drumbeat of recession grew louder after the US economy shrank for a second straight quarter, as decades-high inflation undercut consumer spending and Federal Reserve interest-rate hikes stymied businesses and housing.
Gross domestic product fell at a 0.9 per cent annualized rate after a 1.6 per cent decline in the first three months of the year, the Commerce Department’s preliminary estimate showed Thursday. Personal consumption, the biggest part of the economy, rose at a 1 per cent pace, a deceleration from the prior period.
“The more important point is that the economy has quickly lost steam in the face of four-decade high inflation, rapidly rising borrowing costs, and a general tightening in financial conditions,” Sal Guatieri, senior economist at BMO Capital Markets, said in a note. “The economy is highly vulnerable to slipping into a recession.”
The report will add to political headaches for President Joe Biden and complicate the Fed’s calculus over how aggressively to raise interest rates.
In addition to the slowdown in household spending, the report also showed declines in business investment, government outlays and housing. Inventories also weighed on GDP, while a narrower trade deficit added to the figure.
A key gauge of underlying demand that strips out the trade and inventories components — inflation-adjusted final sales to domestic purchasers — fell at a 0.3 per cent pace in the second quarter compared with a 2 per cent gain in the prior period.
The report illustrates how inflation has undercut Americans’ purchasing power and tighter Fed monetary policy has weakened interest rate-sensitive sectors such as housing. That is likely to throw fuel on an already heated debate about if or when the US enters a recession.
While the common rule of thumb for recessions is two consecutive quarterly declines in GDP, the official determination of ends and beginnings of business cycles is made by a group of academics at the National Bureau of Economic Research.
What Bloomberg Economics Says…
“The contraction in second-quarter GDP significantly raises the risk that the economy will fall into recession by year-end…lagging momentum leaves the economy vulnerable to further adverse shocks such as a potential energy crisis in Europe or intensified supply strains in the second half of the year.”
— Yelena Shulyatyeva and Eliza Winger, economists
The median projection in a Bloomberg survey of economists called for a 0.4 per cent advance in GDP and a 1.2 per cent rise in consumer spending. Two-year Treasury yields tumbled after the report potentially reduced chances of further aggressive Fed rate increases, while the S&P 500 opened higher and the dollar fell.
PROFIT FORECASTS
Retailers like Walmart Inc. and Target Corp. have slashed their profit forecasts, and a slew of tech companies, including Shopify Inc., have announced plans in recent weeks to cut workers. Others, like Apple Inc. and Microsoft Corp. are slowing hiring.
Broader weakness in a labor market that’s shown only limited signs of cooling would remove a key source of support for the economy and help shape the course of monetary policy later this year.
“We think it’s necessary to have growth slow down,” Fed Chair Jerome Powell said at a news conference Wednesday after another 75 basis-point hike in interest rates.
“We actually think we need a period of growth below potential in order to create some slack so that the supply side can catch up. We also think that there will be, in all likelihood, some softening in labor market conditions,” Powell said.
According to a separate report Thursday, applications for unemployment benefits last week were higher than forecast.
The GDP data showed services spending accelerated to a 4.1 per cent annualized rate, though outlays on goods shrank 4.4 per cent. Inflation-adjusted spending data for June will be released Friday.
Americans are facing higher prices for virtually everything from gas to food to rent. Wages have increased but not fast enough to keep pace with inflation, driving consumer sentiment to multi-year lows. The Fed is determined to limit inflationary pressures, some of which are due to factors outside of their control — like Russia’s war in Ukraine.
Powell said that while more rate increases are forthcoming, the sizes of the moves will be data dependent. Currently, “the labor market is extremely tight and inflation is much too high,” he said.
Last quarter, inflation-adjusted business investment eased 0.1 per cent, reflecting declines in both spending on structures and equipment. Outlays on intellectual property products rose solidly.
Residential investment plunged at a 14 per cent annual pace, the largest decline since the start of the pandemic and reflective of how high borrowing costs along with rapid inflation have squeezed the housing market. Sales have been falling for months, and builders are increasingly downbeat about future demand.
How Executives See It
“We seem to have entered an economic downturn that will have a broad impact on the digital advertising business. And it’s always hard to predict how deep or how long these cycles will be, but I’d say that the situation seems worse than it did a quarter ago.” — Meta Platforms Inc. CEO Mark Zuckerberg, July 27 earnings call
“We’re seeing customers and specifically lower-income customers trade down to value offerings and fewer combo meals.” — McDonald’s Corp. CFO Kevin Ozan, July 26 earnings call
“The increasing levels of food and fuel inflation are affecting how customers spend, and while we’ve made good progress clearing hardline categories, apparel in Walmart US is requiring more markdown dollars.” — Walmart Inc. CEO Doug McMillon, July 25 updated guidance
“We do assume a recessionary environment around us… So accordingly, we’ve taken the actions which we have in our recession playbook, which are largely focused on being very aggressive on cost side.” — Whirlpool Corp. CEO Marc Bitzer, July 26 earnings call
The report showed trade added 1.43 percentage points to the percent change in GDP, while the change in inventories subtracted 2 percentage points.
The personal consumption expenditures price index, an inflation measure followed by Fed officials, grew an annualized 7.1 per cent for a second quarter. Stripping out food and energy, the index rose 4.4 per cent after rising 5.2 per cent. Monthly PCE price data will also be released Friday.
Netflix on Thursday reported that its subscriber growth slowed dramatically during the summer, a sign the huge gains from the video-streaming service’s crackdown on freeloading viewers is tapering off.
The 5.1 million subscribers that Netflix added during the July-September period represented a 42% decline from the total gained during the same time last year. Even so, the company’s revenue and profit rose at a faster pace than analysts had projected, according to FactSet Research.
Netflix ended September with 282.7 million worldwide subscribers — far more than any other streaming service.
The Los Gatos, California, company earned $2.36 billion, or $5.40 per share, a 41% increase from the same time last year. Revenue climbed 15% from a year ago to $9.82 billion. Netflix management predicted the company’s revenue will rise at the same 15% year-over-year pace during the October-December period, slightly than better than analysts have been expecting.
The strong financial performance in the past quarter coupled with the upbeat forecast eclipsed any worries about slowing subscriber growth. Netflix’s stock price surged nearly 4% in extended trading after the numbers came out, building upon a more than 40% increase in the company’s shares so far this year.
The past quarter’s subscriber gains were the lowest posted in any three-month period since the beginning of last year. That drop-off indicates Netflix is shifting to a new phase after reaping the benefits from a ban on the once-rampant practice of sharing account passwords that enabled an estimated 100 million people watch its popular service without paying for it.
The crackdown, triggered by a rare loss of subscribers coming out of the pandemic in 2022, helped Netflix add 57 million subscribers from June 2022 through this June — an average of more than 7 million per quarter, while many of its industry rivals have been struggling as households curbed their discretionary spending.
Netflix’s gains also were propelled by a low-priced version of its service that included commercials for the first time in its history. The company still is only getting a small fraction of its revenue from the 2-year-old advertising push, but Netflix is intensifying its focus on that segment of its business to help boost its profits.
In a letter to shareholder, Netflix reiterated previous cautionary notes about its expansion into advertising, though the low-priced option including commercials has become its fastest growing segment.
“We have much more work to do improving our offering for advertisers, which will be a priority over the next few years,” Netflix management wrote in the letter.
As part of its evolution, Netflix has been increasingly supplementing its lineup of scripted TV series and movies with live programming, such as a Labor Day spectacle featuring renowned glutton Joey Chestnut setting a world record for gorging on hot dogs in a showdown with his longtime nemesis Takeru Kobayashi.
Netflix will be trying to attract more viewer during the current quarter with a Nov. 15 fight pitting former heavyweight champion Mike Tyson against Jake Paul, a YouTube sensation turned boxer, and two National Football League games on Christmas Day.
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