DEEP DIVE: Anatomy Of A Rolling Recession

Is the only path forward a painful one, as Fed Chair Jerome Powell recently suggested? Is a recession inevitable now that Powell may be channeling his inner Volcker? Debbie and I still don’t expect that any economic downturn over the rest of this year and/or next year will be severe enough to qualify it as an official recession, i.e., meeting the criteria of the Dating Committee of the National Bureau of Economic Research.

We believe that the economy has been in a “rolling recession” since the start of this year that may continue through the end of this year. The idea is that different economic sectors experience downturns at different times, resulting in a “growth recession” for the broad economy with no significant contraction of GDP—thus skirting a broad-based official recession.

During the first half of this year, real GDP fell slightly led by a recession in the housing industry, a shortage of new autos, and weakness in capital spending on structures. During the second half of the year, housing will still weigh on economic growth, and retailers’ unintended inventory building is already forcing them to cut their prices to clear the excess merchandise. Consider the following:

(1) Residential investment. Among the most interest-rate sensitive sectors of the economy is housing. The 30-year mortgage rate soared 262bps from 3.29% at the start of the year to 5.91% on Friday (Fig. 1). It did so because the 10-year US Treasury yield jumped 152bps and the spread between the mortgage rate and the bond yield widened by 110bps to 287bps over this period (Fig. 2).

This spread widened as fixed-income traders and investors anticipated that the Fed would start reducing its portfolio of mortgage-backed securities during H2-2022 once it had implemented its QT2 program.

Residential investment in real GDP fell 16.2% (saar) during Q2 (Fig. 3). That’s not surprising since this series is mostly determined by housing starts, which dropped from 1.67 million units (saar) in January to 1.45 million units in July led by a plunge in single-family starts (Fig. 4). Multi-family housing starts remained strong during July at 530,000 units because rapidly rising rents are providing a big incentive to develop such properties.

By the way, according to the Bureau of Economic Analysis (BEA), the decrease in residential fixed investment was actually led by a decrease in “other” structures, specifically real estate brokers’ commissions! This suggests that there is more weakness ahead in residential investment to reflect the recent drop in housing starts.