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U.S. in Technical Recession, Dollar Retreats

  • 2 consecutive quarter of negative growth recorded
  • USD gives back some recent gains
  • But NBER unlikely to call official recession
  • Until least until early 2023

U.S. economy

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U.S. GDP read at -0.9% quarter-on-quarter in the second quarter of 2022, making for a second consecutive quarter of negative growth (Q1: -1.6%), fulfilling the technical definition of a recession.

The news is a surprise for investors as the consensus was looking for 0.5% growth quarter-on-quarter, but it is up to the NBER to call an official recession and economists say this won't happen until at least 2023.

The BEA, who compile the GDP data, nevertheless said economic weakness was seem across most GDP components.

"Growth momentum is undoubtedly weakening amid headwinds such as rapid policy tightening, a significant squeeze in real incomes, and falling confidence. We see a bumpy road ahead as the Fed attempts to rebalance supply and demand in the economy and an elevated risk of recession in the second half of 2023 as rates push into restrictive territory," says Hussain Mehdi, Macro & Investment Strategist at HSBC Asset Management.

The sharp slowdown in U.S. economic growth that is underway will underpin expectations for inflation to fall back over coming months, potentially easing pressure on the Federal Reserve to pursue an aggressive policy of interest rate hikes.

The prospect for an end to the rate hiking cycle is meanwhile supportive of investor sentiment as forward-looking markets will already be discounting improved economic growth conditions.

US GDP change

The Dollar fell as a result, giving back earlier gains against both the Euro and Pound Sterling. Stock markets traded higher, according to data from index broker Robomarkets.

The Pound to Dollar exchange rate rose a quarter of a percent in the half hour following the release of the U.S. data to quote at 1.2138. Bank accounts were quoting in the region of 1.1897 on dollar payments and FX specialists were quoting around 1.21 for money transfers.

The Euro to Dollar spot rate rose a third of a percent in the 30 minutes following the data and was around 0.9879 for dollar transfers on bank accounts and 1.0130 at FX payment specialists.

"Where do we go from here?" asks Jonathan Pierce, an analyst at JP Morgan, "I think it makes sense that the USD has relapsed but don't think this necessarily marks the start of a major USD reversal; like the Fed we too are now in data watching mode."

The commonly accepted definition of economic recession is two successive quarters of economic contraction, but it is worth keeping in mind there is in fact no official definition available.

Some economists say the U.S. will only enter recession when the National Bureau of Economic Research (NBER) officially declares one.

Chairman of the U.S. Federal Reserve Jerome Powell said he did not believe the U.S. economy was in recession when speaking to the media following Wednesday's decision to raise interest rates a further 75 basis points.

He pointed out that the labour market was in too healthy a state to meet the definition of recession.

Powell is correct when alluding to the NBER's definition which does not only look at GDP but also the sum of incomes, i.e. wages, profits, etc.).

"In contrast to gross domestic product (GDP), this gross domestic income (GDI) increased by 1.8% in the first quarter (Q2 figures will be released next month)," points out Christoph Balz, Senior Economist at Commerzbank.

"The NBER is unlikely to conclude that the U.S. economy was already in recession in the second quarter. However, we are less certain about the coming months, as most indicators are no longer clearly pointing upward," he adds.

"Bond yields and the USD fell following the disappointing report, as it isn't fully attributable to temporary supply chain snarls, which is consistent with a slower pace of hikes from the Fed ahead," says Economist Katherine Judge at CIBC Capital Markets.

If incoming data does point to stronger economic growth in the third quarter markets will likely start rebuilding Fed rate hike expectations, as stronger data demands a stronger response from the Fed.

This would potentially allow the Dollar to reassert itself.

"Bond yields might not be able to sustain these lower levels over the next few months if upcoming payrolls data and GDP components signal a clear return to positive growth in Q3," says Judge.

Nevertheless, CIBC Capital Markets continues to believe that, contrary to the FOMC dot forecast, rates won't have to get about 3 1/2% to cool inflation, and that hikes won't continue into 2023 as a result.