Rearview Mirror OK, Collision Ahead

First, the good news: we estimate that real GDP grew at a solid 2.8% annual rate in the fourth quarter. But you shouldn’t dwell on the solid GDP report that comes out Thursday. Why? Because the report shows what’s going on in the rearview mirror. Meanwhile, there’s an economic collision ahead.

Just think about the news so far for December. The ISM Manufacturing and ISM Service indexes are both below 50. Excluding the early days of COVID, both indexes haven’t been below 50, signaling at least a contraction in sentiment, since the aftermath of the 2008-09 Financial Panic.

Retail sales fell 1.1% in December after a 1.0% decline in November. Industrial production fell 0.7% in December after a 0.6% decline in November. Medium & heavy truck sales are still at a respectable level, but dropped sharply in December, down 13.5%, the second fastest drop for any month in the past twenty years. Housing starts declined, as well.

The good news is that the labor market still seems strong. Initial claims for unemployment insurance claims are still very low. But the job market is often a lagging indicator of economic health and jobless claims should be expected to be at or near a bottom very close to the peak in the business cycle.

A recession will arrive sometime in 2023. Given recent data, it would come as no surprise if we’re already in a recession and the economy shrinks in the first quarter and beyond. A surge in the M2 measure of the money supply led a rebound in economic growth from the COVID Lockdown and then a surge in inflation in 2021-22. But growth in M2 came to a halt in early 2022. Now, with a time lag, the economy is getting weaker and inflation is coming down. Buckle up, it’s going to be rough ride.