Economy in Brief

A rule of thumb recession signal? I am generally not impressed with the signal of two declines in a row for GDP as an indicator for recession. News reports today are heralding the triggering of a ' technical recession’ signal for the UK, I will once again make the point that two negative quarters of GDP growth in a row is hardly a signal that is ‘technical’ this is a ‘rule of thumb’ judgement that is being rendered.

A rule of thumb signal, but trouble nonetheless The signal and the conclusion of recession based on this quirky measure mostly gives market participants a very quick and dirty way to assess what the economy is doing and how severe its circumstance might be. In this case, however, the depth of the GDP decline appears to be a little bit more severe than we have seen in other countries. The breadth of the declines across GDP categories suggests that this is something more serious than just the observation of two quarterly declines in GDP in a row. The UK economy appears to be in more serious trouble.

One of the first things to notice in the GDP table above is that while GDP has declined for two quarters in a row, it has logged the more severe, 1.4% drop at an annual rate, in the fourth quarter and the more modest -0.5% at an annual rate in the third quarter. Still, domestic demand grew by 1.2% in the fourth quarter after falling by 1.9% in the third quarter, domestic demand is somewhat weak but also choppy and unstable. Yet it is showing some resilience despite the overarching decline in GDP.

Year-on-year weakness, too However, in the lower panel of this table, we also see that this two-quarter decline in GDP, combined with previous quarterly weakness, generates a year-over-year decline in GDP and that makes the two quarter in a row decline a more serious event. In addition to GDP weakness, housing investment is falling year-over-year, exports and imports are both falling. Although, once again, as a counterpoint. domestic demand is rising by 3.1% year-over-year after another solid year-on-year gain in Q3 that began a recovery after a previous period of year-on-yar demand declines.

Weakening production One additional thing that I explore when I see weakness like this, is industrial production. On the industrial production front, we find even more weakness with fourth-quarter growth in the UK and manufacturing falling at a 3.6% annual rate: that's a relatively stepped-up pace of decline. In fact, consumer durables output is falling by 4% at an annual rate, intermediate goods output is falling at an 8.6% annual rate and Capital goods output is falling at a 3.7% annual rate. All of this adds to the notion of the economy weakening severely and broadly and with GDP also lower on balance over one-year this weakness assessment seems to go over the duration hurdle as well.

What makes weakness a recession? The three-metrics we look for to assess recession are (1) the depth of weakness, (2) the breadth of weakness, and (3) the duration of weakness. UK GDP falls quarter-to-quarter at the faster pace of 1.4% annualized in the current quarter. Is weakness gathering momentum? And, while industrial production in Manufacturing falls at an annualized pace of 3.6% in Q4, IP rises by 2.3% year-on-year in December. Still, other GDP components are considerably weak, as housing investment falls by 9% year-on-year, exports drop 10.3%, imports, which are linked to international competition as well as to domestic demand, fall by 2% year-on-year. Clearly domestic demand has helped imports to grow (and domestic demand is a clear positive for the economy, even though in the GDP framework an import rise subtracts from GDP). Exports are a drag on GDP as they fall; their weakness is a clear signal that the international sector is not helping the UK economy at all.

A profile of weakness The UK economy on profile is weaker that the Euro-Area where GDP is simply crawling at a slow-flat pace. The US is a marked contrast showing robust growth and acceleration.

The good news is that UK inflation is falling and that the core rate is on top of the Bank of England’s target over 3-months; the six-month inflation pace is falling sharply, but the targeted 12-month pace is still sticker and well above the target.

Consumer Confidence (GFK) has stabilized and even strengthened but it is still weak and retail sales volumes are weakening.

The overarching view is weak The UK eco-data, not just the GDP report, paint a picture of an economy in decline hinting at several kinds of stresses – but several key stresses are missing too. The pound sterling has remained firm-to-strong on a real effective exchange rate basis. That adds to confidence, but it does not assist in generating growth through exports. Various CBI surveys show a weakening economy. Surprisingly, the UK PMI surveys for manufacturing and services have been strengthening. The cyclically sensitive passenger car sector has been relatively steady, and the UK job market has been ‘resilient.’ When recessions hit the job market that is when the fur really begins to fly and various knock-on effects spread. Moreover, the financial sector is still stable.

Fine until it’s not… Of course, in recession, everything can be simply fine until it isn’t. The analogy that it is a little like a dam bursting is illustrative. Before it breaks, everything is fine, some may have had a premonition and may have taken action. Then, suddenly it isn’t OK. When the dam breaks, various things are set in motion and those on high ground may be protected – if it is high enough. Who is protected in a recession is always hard to say; it depends on the kind of recession, and its severity and the speed of its onset. The Covid recession, for example, was an extreme event, very sharp, very broad...and very short. But the aftermath of the recession is also a period of ongoing disruption in which repairs are being made. Normalcy does not instantly set in when recession ends. Some recoveries are still painful. For now, The UK economy is showing some unraveling, but it is also still at a measured pace. This could be an inflection point where things either get worse or where this is the worst of it, and conditions settle down. The stable jobs market and stable financial sector are points in favor of this remaining a tempest, that only modestly spills out of the tea pot. But the UK is clearly in a zone where there is merit to close-watching. The Conference Board LEI for the UK has weakened sharply and that also bears watching, however, internationally LEI signals have not been having their finest hour.

There will be no hearts and flowers for GDP growth in the European Monetary Union on Valentine's Day. However, the revisions to GDP have kept the growth rate from turning negative in the fourth quarter (Q/Q measure). The third quarter negative number for Q/Q growth gave rise to concerns that the revision to GDP could take forth quarter growth into negative territory and that would trigger the analysis that the economy had dipped into recession.

Really?

‘Technical’ recession? Ha! You may read articles saying that the economy has avoided ‘technical’ recession. However, I don't know about you, but since very early elementary school I haven't thought of 1 + 1 equaling 2 being ‘technical’ for quite a while. The notion that two consecutive quarters of negative GDP growth are recession is anything but a technical definition of anything. Instead, that is a ‘rule of thumb’ definition of recession. And a rule of thumb is anything but technical, it is ‘one-off,’ ‘on the fly,’ a ‘quick study.’

The notion of two consecutive quarters as a recession I believe has been popularized because it can take the official agencies that designate periods as recessions quite a while to make the call that the economy is in recession. And the notion that two consecutive quarters of negative GDP growth mark a recession is something that's simple and can be known immediately.

On the other hand, taking a rule of thumb like this as something that is literally true obviously has shortcomings. There are also good reasons not to have a knee-jerk fast declaration of recession. European Monetary Union GDP fell by 0.5% at an annual rate in the third quarter of 2023; it's now risen by 0.2% at an annual rate in the fourth quarter. Had it been three tenths of a percentage point weaker (at an annual rate in the fourth quarter) would it really have made that much difference to anything?

I don't think so.

One bullet dodged The U.S. has already, in the post COVID period logged two consecutive quarters of negative GDP growth without having anyone (except a few with a political axe to grind) seriously suggesting that the U.S. economy was in recession during those two quarters. The declines in GDP for the U.S. were modest and at the same time job growth was enormous during those quarters.

What recessions are Recessions are special periods; and, while the extreme economic weakness in the U.S. economy during COVID was barely three months long, that period has been designated a recession. It should not be a poster child for recession dating. The point is that the COVID period was very unusual. The decline in GDP was extremely severe, and it was broad across the economy. However, the period was also extremely short. When recession daters look at recessionary candidate periods, they're looking to find economic activity that has been (1) severely impacted, (2) that has affected the economy broadly, and (3) that has lasted for a sufficiently long period of time to disrupt the economy and earn the designation as a recession. This is why it generally takes recession-dating experts some time before they pull the trigger on calling a period a recession or not. The COVID period is a notable example of a period that was very short and did not fulfill the length criterion but had impacted the breadth and the depth criteria so deeply that it was construed as a recession anyway. The main reason for this is probably the severe increase in the unemployment rate that occurred even though that unemployment rate during recovery came down quite rapidly.

The trappings of recession In Europe, we see none of the trappings of recession. The sense already is that inflation has flared and is starting to come down. We are not left with the opinion that the central bank is going to have to keep pounding interest rates higher until the economy is pulverized. Unemployment rates throughout the European Union remain extremely low and among the the lowest as a group that the Monetary Union has had since it was formed. But there are still a lot of economic risks and things that could go wrong. But the economy simply does not exhibit a lot of the characteristics we would need to see to support the call of recession. Financial distress is mostly absent.

Soft growth and political pressure However, the European economy is in a definite soft spot, a flat spot, and it's underperforming. The proximity of the European Monetary Union to the war in Ukraine is one of the main reasons. And now with more conflict in the Middle East with the Suez channel shuttered, there is another blow that the European economy will have to deal with. Europe, like the U.S., is beginning to creak under the burden of supporting the war in Ukraine. And there has been political backlash from this support in the U.S. in the form of concerns about all the spending that helps people on foreign shores. While in the European Monetary Union, the most immediate recent impact has been on farmers who are concerned about cheap Ukrainian grains in the EMU and the removal of gasoline subsidies to the farm sector that is already under pressure.

Growth data have some positives The table shows both quarter-to-quarter data for the most recent three quarters and year-over-year data for the previous four-quarters. Year-over-year data show only one country’s growth rate observation in Q4 is decelerating compared to the year-over-year growth rate in the third quarter. GDP on a year-over-year basis is not broadly decelerating in the European Monetary Union or across most of its early reporting members- the Netherlands is the lone exception. This is a far more important observation than the fact that 0.2% is a positive number and it's not -0.1%. Similarly, quarter-to-quarter growth shows broader increases in Q2 compared to Q1 and broadly increases in Q4 compared to Q3, while the third quarter shows widespread growth decelerations that appear now be a one-quarter phenomenon- peak weakness was Q3.

The U.S. as bellwether If the U.S. is an indication, the global economy is beginning to pick up. Global PMI data already are showing indications that the service sectors have stopped slowing and the manufacturing sectors - on whatever metrics they have been reporting - are not getting weaker.