Introducing

Joseph G. Carson

Joseph G. Carson, Former Director of Global Economic Research, Alliance Bernstein.   Joseph G. Carson joined Alliance Bernstein in 2001. He oversaw the Economic Analysis team for Alliance Bernstein Fixed Income and has primary responsibility for the economic and interest-rate analysis of the US. Previously, Carson was chief economist of the Americas for UBS Warburg, where he was primarily responsible for forecasting the US economy and interest rates. From 1996 to 1999, he was chief US economist at Deutsche Bank. While there, Carson was named to the Institutional Investor All-Star Team for Fixed Income and ranked as one of Best Analysts and Economists by The Global Investor Fixed Income Survey. He began his professional career in 1977 as a staff economist for the chief economist’s office in the US Department of Commerce, where he was designated the department’s representative at the Council on Wage and Price Stability during President Carter’s voluntary wage and price guidelines program. In 1979, Carson joined General Motors as an analyst. He held a variety of roles at GM, including chief forecaster for North America and chief analyst in charge of production recommendations for the Truck Group. From 1981 to 1986, Carson served as vice president and senior economist for the Capital Markets Economics Group at Merrill Lynch. In 1986, he joined Chemical Bank; he later became its chief economist. From 1992 to 1996, Carson served as chief economist at Dean Witter, where he sat on the investment-policy and stock-selection committees.   He received his BA and MA from Youngstown State University and did his PhD coursework at George Washington University. Honorary Doctorate Degree, Business Administration Youngstown State University 2016. Location: New York.

Publications by Joseph G. Carson

• USA| Dec 06 2022

  Record Profit Margins Suggest It's Been A "Pain-Free" Tightening Cycle For Companies

  "It ain't over until it's over," quoting Yogi Berra, but this has been a "painless" tightening cycle for companies. According to the profit data for nonfinancial companies, profit margins (adjusted for inflation) for the first three quarters of 2022 have averaged 15.6%, essentially matching last year's figure, which was the highest in 60 years.

  In previous Fed tightening cycles aimed at slowing and reversing cyclical inflation forces, real profit margins declined, and by a lot. Declines of 200 to 500 basis points in real profit margins occurred during the tightening cycles of 1980, the 1990s, and the 2000s.

  What makes this period different? For one, the rise in official rates, while significant in scale, up 400 basis points from the start of the year, is still far below the 6.3% rate of core inflation for the twelve months ending in October. And the nominal level of federal funds at 4% is still 500 basis points below the 9.2% growth in nominal GDP for the year ending in Q3 2022.

  In short, the price increases have exceeded total unit costs for nonfinancial companies (including labor, materials, and credit borrowing). A 'pain-free" tightening cycle is not how inflation cycles end. In previous tightening cycles, companies felt the "pain" of higher interest rates, resulting in layoffs and cutbacks in spending.

  In comments at the Brookings Institution, Fed Powell said, "my colleagues and I do not want to over-tighten... that's why we're slowing down and going to try to find our way to what is the right level is". As Yogi Berra said, "You've got to be very careful if you don't know where you are going because you might not get there." Since the Fed does not know where they are going, how should investors know? Investors should expect a volatile 2023.

  by:Joseph G. Carson

  |in:Viewpoints
• USA| Nov 29 2022

  The Big Risk in 2023 For the Fed & Investors---Slowdown in Inflation Proves To Be "Transitory"

  Federal Reserve policymakers are considering implementing smaller rate hikes, acknowledging the lagged effects of previous rate hikes and better news on inflation. Investors have been running with this bullish view that the apparent slowdown in core inflation, along with declines in commodity prices, changes the inflation outlook so that policymakers would scale back and possibly end their rate-hiking experiment in early 2023.

  The rally in equities has been impressive. From the low on September 30, the Dow Jones is up 20%. If the equity market follows the historical pattern between the second and third year of presidential terms, there is much more to go. The average gain in the Dow Jones average from the low in the second year to the high in the third year has been 45%. A Fed pivot could be the catalyst for additional gains into 2023.

  The risk to that optimistic scenario and sustainable equity market gains for 2023 is that the inflation slowdown could be "transitory."

  Suppose that the Fed raises official rates by 50 basis points at the December 13-14 meeting and follows that with another 50 basis points hike in early 2023. That would lift the federal funds rate to 5%. And if core inflation continues to run at 0.3% for the next five months, the twelve-month reading on core inflation in March 2023 would be 5.25%.

  What are the odds of the Fed beating the current inflation cycle and bringing core inflation back to the 2% target with nominal rates below the inflation rate? History would say the odds may not be zero, but they are low. Official rates of 300 to 500 basis points above-reported core inflation broke the inflation cycles of the 1980s and 1990s.

  Here are three reasons why the slowdown in inflation could prove to be "transitory."

  First, individuals are sitting on a cash bundle. At the end of Q2, households had $18.5 trillion in checking accounts, time deposits, and money market funds, equaling approximately 25% of total liquid financial assets, the highest share since the financial crisis. A Fed pivot could easily trigger a big risk-on rally in equity markets ("FOMO," fear of missing out, has not been retired), with spillover effects in the real economy. A rebound in equity prices, lifting consumer wealth, would boost consumer sentiment and trigger more robust consumer spending.

  Second, the Fed rate hikes have hit the housing market hard. Home sales and new construction has slowed a lot in the past year. Yet, the number of existing homes for sale at 1.2 million in October is low and well below the level before the pandemic. The cost of mortgage borrowing, currently around 6% +, might look high nowadays, but that could change quickly in a risk-on environment when people's price expectations for housing starts to rise against a very low inventory backdrop. A more robust housing market would increase demand for commodities and consumer goods, lifting prices. And it has been the recent decline in consumer goods prices that have been responsible for the slowdown in core inflation.

  Third, labor markets remain tight, with an unemployment rate of sub-4% and almost twice as many job openings as the number of unemployed. The jobless rate increased by over 200 basis points and remained relatively high for a few years following the tightening cycles of the late 1980s and 1990s. That helped sustain the slowdown in core inflation. Continued tightness in the labor markets is the biggest hurdle to achieving a sustainable slowdown in inflation as it maintains wage-cost pressures.

  Policymakers will soon face Yogi Berra's "fork in the road." Will policymakers turn left (pause) or right (continuation of rate hikes)? Investors are betting on a left turn, expecting a rally in the short run. A right turn would create more pain in the short run but offer a better path for sustainable long-term gains.

  by:Joseph G. Carson

  |in:Viewpoints
• USA| Nov 03 2022

  We Were All Wrong: The Starting Point Was Zero

  When policymakers started to raise official rates in the spring, the official projections showed an official peak rate of 2.8% at the end of 2023. With inflation running much faster at the time, I argued that the peak rate could be as much as 100 basis points higher than what the Fed was telegraphing. We were all wrong.

  Four consecutive seventy-five basis points increases and three hundred and seventy-five basis points in eight months look like a substantial increase in official rates. But the starting point was zero, and much more is still needed to reverse inflation risks.

  Price increases lead to revenue and profit increases for companies, while wage increases trigger income gains for workers. So when the price cycle broadens and wages increase, it takes more and more rate hikes to break the cycle because higher profits and income offsets the higher borrowing costs.

  In October, core consumer prices were up 6.7% from one year ago, while average wages for non-supervisory workers increased by 5.9%. Price increases are 260 basis points above last year's gain, while wage increases are roughly the same. At 4%, the fed funds rate is still far below the price and wage gains, so there is more ground to cover before the policy is even neutral, let alone restrictive.

  Businesses and consumers do not borrow at the fed funds rate. But the federal funds rate is the benchmark for all borrowing costs, so for market rates to be at levels that restrict borrowing, the Fed needs to lift rates to prohibitive levels. The fed funds moved above price and wage gains in the past three cyclical inflation cycles (the 1980s, 1990s, and 2000s).

  So we all were wrong. Fast and broad price and wage gains require higher official rates.

  by:Joseph G. Carson

  |in:Viewpoints
• USA| Oct 19 2022

  Near-Record High Profit Margins Indicate the Fed Is Not Winning the Inflation Battle

  The resiliency of the corporate sector has been one of the surprises in 2022. Despite a volatile and uneven economy and a series of interest rate hikes from the Federal Reserve, the corporate sector has maintained record profitability and near-record profit margins. The high-profit margins may be the biggest surprise as it confirms that cost increases have been passed along and not absorbed. That dynamic makes the Fed's job of slowing inflation much more difficult, as it shows an "acceptance" of price increases.

  In 2021, real operating profit margins for nonfinancial companies stood at 15.7%, the highest level since the mid-1960s. Surprisingly, companies simultaneously passed along the higher costs of materials, supplies, and labor and lifted margins in the process. And the spread of 275 basis points between final prices and total unit costs was the second widest since the 1960s.

  Real operating margins have remained relatively high in the first half of 2022. At 15.5%, real profit margins for nonfinancial companies are still 300 basis points above the levels that were in place before the pandemic.

  Q3 data on profit margins are not yet available. But, the price and wage data suggest margins held up if not expanded. To be sure, core consumer prices of 6.4% annualized and core producer finished goods prices of 7% were 100 to 175 basis points over the increase in wages for non-supervisory private workers. Firms' total unit costs were probably lifted somewhat due to rising finance costs.

  High-profit margins help to explain why job growth has continued to be so strong this year. Companies added over 1 million workers in the third quarter, about the same number as in the prior quarter. That robust pace of hiring is not something that one would expect if companies, in the aggregate, were experiencing intense downward pressure on margins from rising costs.

  Policymakers will never publicly admit this, but the Fed wants an environment where companies cannot pass along cost increases into final prices. That would lead to a decline in margins, a typical outcome during slower growth periods or recessions, eventually forcing cost cuts, including layoffs, less demand, and slower inflation.

  Policymakers place a lot of emphasis on inflation expectations, but that is a "soft-data" measure of what people would like to see or expect versus what they are doing or accepting, as is captured in the "hard data" measure of companies' profit margins. Near-record high-profit margins indicate the Fed's job of fighting inflation is far from over, raising the risk that official rates have to go much higher than is shown in policymakers' dot plots or future prices.

  Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.

  by:Joseph G. Carson

  |in:Viewpoints
• USA| Oct 10 2022

  Investors Should Be Cautious Of A Policy Pivot: Volcker Showed Quick Policy Pivots Don't End Well

  Investors should be cautious of a policy pause or pivot as it might bring short-term gain at the expense of long-term pain. No one is better than Mr. Volcker at knowing that quick pivots or reversals in the fight against inflation don't end well. Mr. Volcker abandoned his inflation fight in early 1980 following the sharp plunge in the economy (at the time, it was the sharpest one-quarter drop in GDP in the post-war period) associated with the imposition of credit controls.

  After lifting official rates by more than 1000 basis points over several months, Volcker dropped them equally fast, only to resume his inflation fight later in the year. Volcker eventually raised official rates to higher highs in the next two years, underscoring the critical point of inflation cycles; that they do not die quickly or easily.

  Nowadays, there is nothing on the horizon that would trigger an economic decline equal to that of the 1980's drop. But that's not the critical point. Killing inflation cycles require a significant reset of economic and financial conditions following a fundamental tightening of monetary policy. The sharp two-day rally in equities this week based on the slightest hint of a policy pause shows investors' risk-taking appetite is alive and well. If that is still alive, so is the economy's growth and inflation appetite.

  Yet, it is hard to deny that things are lining up for Fed Powell to pause at some point. For example, prices paid diffusion indices from the Institute of Supply Management for manufacturing and the service sector provides a snapshot of cost pressures. Both price measures fell to their lowest levels in roughly two years in September.

  Yet, it is worth noting that diffusion indexes track the breadth of increases (or decreases) and do not distinguish the magnitude of change. So while cost pressures have subsided, they have not disappeared completely. Also, the service sector's price index at 68% remains elevated, which has to do with two things: services use fewer commodities than manufacturing, and labor is a more significant part of their cost. Since the inflation cycle is increasingly becoming a service sector phenomenon, rising labor costs remain the biggest wild card for the inflation cycle.

  The number of job openings stood at 10 million in August, off 1.1 million from July, but still far above pre-pandemic levels. And, with 1.7 job openings for every unemployed worker, companies, especially in the service sector, will need to pay up to attract labor.

  Tightness in the labor markets will not be an obstacle for Fed Powell to pause after the Fed follows through on hiking rates at the next two meetings, as suggested in the latest policymakers' projections. Yet, it does create the risk of a pickup of inflation and higher official rates later. That's because, without sufficient slack in the labor markets, companies would still face the same labor cost conditions as they do today, raising the prospect of an extended inflation cycle.

  Inflation cycles are not linear, nor do they end in a day, week, or month. It takes time to stop and reverse. Policymakers say they must maintain restrictive policy rates for some time to kill inflation. Yet, will politics and investors let them?

  Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.

  by:Joseph G. Carson

  |in:Viewpoints
• USA| Sep 29 2022

  Is Deflation A Risk, Or Are These Prognostications A Spurious Call For A Fed Pivot?

  Consumer price inflation is at its highest rate in decades, yet some equity managers are screaming that deflation is the most significant risk. Is deflation a credible risk, or are these prognostications a spurious call for a Fed pivot? It's the latter.

  First, the US has never recorded one year of deflation in core consumer prices in the sixty-plus years that the Bureau of Labor Statistics has collected data. Think about that. There have been several years of high unemployment, with the jobless rate exceeding 8% and a few at 10%-plus. Also, the US experienced record wealth losses following sharp drops in equity and real estate prices, abrupt drops in commodity prices, and near-collapse in the banking system in 2008-09, and not one year of a decline in consumer prices. That does not mean the future risk is zero. Still, going from high to negative inflation in months has to be exceptionally low. Also, economic and financial conditions would have to get significantly worse, above and beyond what has happened in the past, for a prolonged period before deflation risks would be the dominant worry.

  Second, many equity managers form their opinion on inflation/deflation risks based on changes in commodity prices, especially energy. But, commodity prices are inputs into the production process and have a small weight in the overall cost of operations. Also, the US uses more commodities than it produces, so a fall in commodity prices is usually bullish for growth as it frees up cash flow and increases demand (and prices) in other areas.

  Third, it is surprising that some equity managers view deflation as bullish for equities. Price is what companies get for their goods and services. A broad decline in final goods and service prices equates to less revenue and slimmer margins for many companies as firms can't cover or offset the cost of labor and other things. Some of the lowest operating profit margins on record occurred during low consumer price readings. Those periods happened against relatively high unemployment, which is not the case nowadays. So it's hard to see how deflation is bullish for equities, especially in the current environment of job openings exceeding the number of jobless by a factor of two, pushing up the cost of labor.

  Fourth, the primary motivation of portfolio managers' deflation calls appears to be a campaign to pressure the fed to stop and eventually reverse the rise in official and market interest rates. Higher interest rates are a double whammy for equities as they hit growth and earnings and reduce the market multiple, or what people will be willing to pay for future profits.

  Suppose the Fed keeps on the current path of raising official rates to get consumer price inflation back to 2%. In that case, equity PMs might eventually get the policy reversal they are presenting with their spurious calls about deflation risks. But that path will be rocky, with sharp declines in operating earnings, corporate bankruptcies, and a rise in credit default rates. The risk of the latter occurring is much higher than the risk of deflation, which is not a friendly environment for risk assets.

  Deflation is not the magic wand to turn the equity market fortunes around, but that doesn't mean some PMs won't stop talking about it.

  Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.

  by:Joseph G. Carson

  |in:Viewpoints
• USA| Sep 14 2022

  Inflation Cycles Are Not Static; They Rotate and Broaden

  The August report on consumer prices should end the discussion of peak inflation, deflation risks, and the quick end to the Fed tightening cycle. But it won't. The happy prophecy of this inflation cycle ending without a lousy outcome fails to learn from past episodes.

  Lessons from past cycles show that inflation cycles are not static or linear; they rotate and broaden. Some items post significant increases in any given month, others smaller ones, and a few none at all. Months later, the composition of inflation could be completely reversed, with items that were not rising at the outset beginning to run faster than others.

  Earlier this year, rapid price increases in a few items were mainly responsible for the acceleration in inflation. For example, at the end of Q1, gasoline prices increased 48% from a year ago, used cars 35%, airline fares 24%, and new cars 13%. These price spikes reflected supply shortages and the rebound in demand from the idle days of the pandemic. Much of that inflation has reversed, but the more significant broad inflation cycle lives on.

  The Bureau of Labor Statistics (BLS) provides special aggregate price series that remove the noise from these factors, the spike in food prices, and the controversial shelter index. In August, BLS estimated that CPI less food, energy, shelter, and used car and truck prices rose 0.5% in the month and now stands at a new cycle high of 6.3% in the past year. The annual increase is the largest since 1982.

  Inflation cycles are complex, with many interconnected parts. Consequently, taming or reversing the inflation cycle is not as simply slowing or ending the price increases for those items that spiked early on. The drop in consumer goods or commodities, especially energy, is good, but inflation in the service sector is much more difficult to eradicate with monetary policy. That's because it is linked directly to labor costs, and labor nowadays is in short supply.

  Investors are waking up to the view that the Fed has much more tightening before it can confidently conclude the inflation cycle is over. Policy rates of 4% or higher are possible, given the changing nature of the inflation cycle. And because of that, I am reminded of what a former colleague and Wall Street strategist, Bob Farell, claimed bear markets have three stages, "sharp down, reflexive rebound and drawn-out fundamental downtrend." The last stage can last a while and be ugly.

  Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.

  by:Joseph G. Carson

  |in:Viewpoints
• USA| Sep 09 2022

  Inflation Cycle Shifts Towards Services, Making It More Difficult For The Fed To Reverse

  At the start of the third quarter, there were 10 million job openings in the private sector, and seventy-five percent were in the service sector. The imbalance in the labor markets, especially for service workers, creates a nightmare scenario for the Federal Reserve. That's because as it attempts to slow demand, dampen wage growth, and cool inflation, its monetary tools are much less effective in dealing with the less interest-rate sensitive service sector.

  Up to now, the hottest inflation issue was commodities, even excluding food and energy prices. But the composition of the inflation cycle is quickly shifting towards consumer services, making it more difficult to reverse without a dramatic drop in demand due to a prolonged period of higher interest rates.

  Core inflation in consumer commodities stands at 6.8%, well off its double-digit highs from earlier than in the year. Yet, prices for core consumer services at 5.6%, the fast annual gain in roughly 25 years, are still accelerating. And core consumer services have nearly three times the weight of core consumer commodities.

  Thus, solving the inflation problem requires a fundamental change in service sector growth dynamics. And that cannot occur without a dramatic shift in the demand and price of service sector labor.

  Before the pandemic, the private sector service job growth was 1.5 to 2 million per year. So reducing the 7.5 million job openings in the service sector by half would take two years. But that would not mitigate wage pressures, the most significant source of service sector inflation.

  The average wages for the private sector non-supervisory service sector workers are up 6.2% in the past year. Excluding the spike in wages in the early months after the pandemic, service sector wages are running at their fastest pace since the early 1980s. And, they are running roughly 100 basis points above the gains in the goods-producing industries.

  Private service sector labor and price dynamics are the Fed's most significant hurdles in its inflation fight. Creating slack in the labor market for service workers will require a much official rate and in place for an extended period than it would if inflation was only a goods sector phenomenon.

  So Fed Powell's warning that "a lengthy period of very restrictive monetary policy" will be needed to stem the inflation cycle is something investors should not ignore, as it signals a volatile market environment.

  Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.

  by:Joseph G. Carson

  |in:Viewpoints
• USA| Aug 24 2022

  Investors Bet The "Bear" Is Over, But the "Bear Cycle" of Lower Inflation & Less Profits Is Not

  The recent rally in equities, bonds, and the narrowing credit spreads has been impressive. It hinges on the view that the Fed's war against inflation is over, or almost so, and a new economic and profit cycle will begin soon. Yet, the downcycle in prices and the fallout in the economy and company profits has not started yet.

  For investors looking beyond the economic slowdown, it is mathematically impossible for the Fed to lower inflation to 2%, from the current 8% to 9% range, without triggering a sharp decline in operating profits.

  In the last twelve months, nominal GDP has increased by 9.3%, with the price component rising 7.5% and the output component rising 1.6%. And what happens on the output side also occurs on the income side since nominal GDP and Income are mirror images.

  In the past year, nominal income has been up an estimated 10%, a bit more than the reported 9.3% gain in GDP, with employee compensation rising 10% and operating profits less than 3%.

  The Fed does not directly target GDP prices. Still, consumer prices make up the lion's share of GDP prices, so lowering consumer price inflation to 2%, down from 8% to 9%, would result in a dramatic drop of about 500 to 600 basis points in Nominal GDP growth, with a parallel downward move in nominal income.

  In the last 30 years, nominal GDP growth has dropped that much three times (1989-90. 2000-01, and 2007-09), excluding the pandemic non-economic recession. Each of the three sharp declines in nominal GDP resulted in an official economic recession, with 2007-09 being the worst one of the post-war period at that time. Aggregate operating profits posted negative numbers before and sometimes during the recessions.

  What makes the current situation unique is that the Fed is fighting inflation against a backdrop of a labor shortage. How does the Fed squash inflation when labor costs are rising? And for investors, the more significant issue is what happens to companies operating profits if Fed lowers inflation and nominal output and income growth slow accordingly, and employee compensation slows only half as much. That points to a sharper decline in operating profits far more significant than analysts and strategists expect.

  The scenario that could be a win-win for investors is if the Fed raises official rates, inflation slows, and real output increases. That would result in a smaller decline in operating profits. In my view, the odds of that occurring are very low as it has never happened before.

  Some may disagree, citing the 1994/95 slowdown. Back then, the Fed was trying to stop inflation from accelerating. This time the Fed is trying to lower a significant and broad inflation cycle, the biggest in 40 years. The economic and financial consequences are much different when inflation has accelerated. Price increases have already inflated income and profit figures, so unwinding inflation creates more harm and dislocation than trying to stop it from occurring in the first place.

  Yet, investors disagree and are betting that ending inflation cycles do not trigger the economic harm, profit, and job declines of past cycles. It is hard to fight the tape, but it's even riskier to defy economic common sense.

  Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.

  by:Joseph G. Carson

  |in:Viewpoints
• USA| Aug 09 2022

  Recent Divergence Runs The Opposite; Household Employment Gains Outpace Payroll

  The Bureau of Labor Statistics (BLS) publishes two estimates of job growth each month: one based on a survey of households and the other based on a survey of firms. The increasing disparity in recent months has created confusion over the size of job gains, as the payroll survey shows robust gains, while household employment is down one month and up the next. Some analysts and portfolio managers have used the household employment data to support their view that the economy is in recession. They're wrong.

  The two surveys are not strictly comparable. But BLS publishes a household employment figure adjusted to payroll survey concepts. And, when modified, the household series shows solid gains, even outpacing the payroll's whopping increase in July.

  To estimate the household employment series equivalent to the payroll series BLS removes from the initial estimate of household employment agricultural workers, unpaid family workers, paid private household workers, and workers on unpaid leave and adds multiple jobholders.

  In July, the household series adjusted for payroll concepts rose 611,000, far above the published gain of 179,000 for household employment and above the 528,000 payroll gain. The series also shows that household employment rose by 131,000 in June, whereas the regular series shows a decline of 315,000. Since the start of the year, the adjusted household series has outpaced payroll jobs by 216,000.

  In the end, the divergence runs the opposite, with household employment outpacing payrolls, and the jobless rate at 3.5%, a 50-year low, confirms that strength. The labor market data says the economy is not in recession.

  Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.

  by:Joseph G. Carson

  |in:Viewpoints
• USA| Jul 28 2022

  Q2 GDP Does Not Confirm Economic Recession, But It Does Confirm A Corporate Profit Recession

  The preliminary report on Q2 GDP does not confirm the US economy is in recession, but it does suggest that a corporate profit recession is underway.

  Q2 Real GDP declined 0.9% annualized, following a 1.6% decline in Q1. Back=to-back quarterly declines in GDP are rare and usually occur when the economy is in recession. Yet, the drop in real GDP during the first half of 2022 is preliminary and not confirmed by the income side of the GDP accounts.

  For example, Real Gross Domestic Income (GDI) expanded 1.8% in Q1, or 340 basis points faster than real GDP. That's a record gap. The long-run average is zero. In other words, Q1 had $677 billion more real GDI and $836 billion in nominal GDI than real and nominal GDP. That makes no sense. Q2 GDI data is unavailable, so it's unclear whether the income side confirms the second quarterly drop in real GDP.

  Research has shown that the initial GDI reports are more accurate than GDP. Perhaps that is true because GDI has fewer data inputs. 80% of GDI comes from employee compensation and operating profits, whereas the GDP numbers include hundreds of series on sales, shipments, and inventories, many of which are revised a lot.

  The Bureau of Economic Analysis plans to issue a report in September on the record gap between GDI and GDP.

  The preliminary GDP report does not include an official figure on operating profits. But one can derive an estimate from the GDP data. Based on my calculation, Q2 operating profits will come in around $2,650 billion, off 6% from a year ago. That would be the second consecutive quarterly drop in operating profits, pushing the corporate earnings to their lowest level since Q1 2021.

  Back-to-back declines in corporate profits are more common than back-to-back declines in GDP. In 2015, operating profits fell for four consecutive quarters, and the economy did not enter a recession.

  Additional downward pressure on profits will probably come from further official rate hikes and slowing or declining economic growth. That might signal an economic recession down the road, but it would be wrong to conclude that the US is in recession today.

  Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.

  by:Joseph G. Carson

  |in:Viewpoints
• USA| Jul 20 2022

  No Recession Call Can Be Made Before BEA Explains The Record Gap Between Income & Output

  Before the academic arbiters debate whether the economy is in a recession, the Bureau of Economic Analysis (BEA) must first examine and hopefully find answers to the unprecedented and growing gap between income and output in the GDP accounts.

  In Q1, Gross Nominal Income (GDI) exceeded Gross National Product (GDP) by a record $836 billion annualized. The gap widened by roughly $220 billion from the fourth quarter of 2021. That increase was sufficiently significant to produce two different outcomes--- GDI, adjusted for inflation, posted a small gain, while GDP, adjusted for inflation, recorded a decline.

  In theory, the two series measure the same thing (the economy). But, in practice, there are substantial differences, but nothing on the scale of the past few years.

  GDP measures the final output of goods and services, which involves many different series of sales, shipments (domestically and overseas), construction, inventories, and a wide range of private and public services. GDI measures the income associated with the output side, with employee compensation and operating profits accounting for 80% of the total and interest income and investment the remaining portion.

  The income side of the accounts is not as timely as the product side. For example, BEA offers a preliminary estimate on the output side less than 30 days after a quarter ends. But, details on the income side are delayed 60 to 90 days due to companies reporting on operating profits.

  Still, I have always felt that the income side is neater, as it has far fewer series and revisions than inputs in the output figures. And support for that view comes from a Fed staffer. He argued that GDI is probably a better indicator since his research found the initial estimates of GDI are much closer to the final numbers of both series.

  The consensus expects Q2 GDP to show a slight decline when reported on July 28. Back-to-back declines will surely increase talk of recession, but it would be wrong to jump to that conclusion when the gap between income and output has quadrupled in the past two years, and GDI is still increasing in real terms.

  BEA is investigating this issue. But it will take months before they issue any report.

  Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.

  by:Joseph G. Carson

  |in:Viewpoints