Don’t be fooled by a strong GDP report

By Nicole Goodkind, CNN Business

Imminent recession is the topic du jour. From Goldman Sachs to the IMF, analysts and economists seem to agree that an economic downturn is coming for the United States in early 2023. That’s why it’s so surprising that the US economy is expected to show robust growth in Thursday’s third-quarter GDP report.

But investors should be wary of a positive headline number. Economists warn that the report could be a one-hit-wonder that overstates momentum in an economy that is actually slowing.

What’s happening: Gross domestic product, a broad measure of economic activity, is estimated to have grown by 2.4% between July and September, according to Refinitiv. That’s huge considering that we’ve just had six months of economic contraction.

That decline, coupled with persistent inflation and rising interest rates, led many to believe that the US was recession-bound. One quarter of growth won’t necessarily change that, say economists who see this as less of a saving grace and more of a bump before the slump.

“Going forward, growth could well turn negative in the fourth quarter and will likely be very weak over the next year,” wrote David Kelly, chief global strategist at JPMorgan Asset Management in a note on Monday.

Mortgage rates have more than doubled since the start of the year. The US dollar is now up almost 20% year-over-year when weighed against a basket of its six closest peers. (Its strength can hurt US exports and the overseas profits of US companies, which could weaken growth.) The federal budget deficit, meanwhile, has been slashed in half, which indicates reduced government spending.

“There is more braking power being inflicted on the US economy than will be at all apparent in the third-quarter GDP report,” wrote Kelly.

Unless the United States experiences a deep recession and subsequent recovery, or labor force participation rates and productivity suddenly soar upwards, “there is little reason to expect booming growth at any time over the next few years,” he added.

Moreover, third-quarter GDP is likely to be elevated by a narrowing gap between exports and imports. But that’s because the United States is importing fewer goods as demand dries up. If you lift the hood up and examine the numbers, said Andrew Patterson, a senior economist at Vanguard, you’ll see that the American consumer and businesses are actually spending less. That’s a bad sign.

The numbers will also be propped up by an increase in retailers’ inventory levels, which are beginning to rebound from supply chain problems earlier in the year.

What the Fed is looking for: Investors will be parsing Thursday’s economic data for clues about the Fed’s interest rate decision at its policy meeting next week. Central bank officials are going to be looking at underlying metrics in the report, and will likely ignore headline numbers, said Patterson.

There are three categories in the report that the Fed will pay particular attention to, said Paterson. The first is whether businesses are investing in their future growth by purchasing things like new machinery. The next is residential investment, which measures home construction and remodeling and signals a healthy housing market. The third is household consumption, a measure of how much money Americans are spending on goods to meet their everyday needs like food and clothing.

Paterson says he expects inflation-adjusted household consumption numbers to have declined. “They may be outright negative,” he said.

The bottom line: The rejiggering of trade balances often falsely inflates economic growth calculations ahead of a recession. Inflation-adjusted GDP reflected healthy gains around the onset of four out of the last six downturns, Joseph LaVorgna, chief economist at SMBC Nikko Securities America and former Trump White House economic adviser, wrote in a note.

The economy is not out of the woods, even if Thursday’s headline GDP number shows a rebound.

Consumers aren’t feeling confident

US consumer confidence fell in October to the lowest level since July as high borrowing costs and soaring inflation take their toll on household budgets, reports my colleague Alicia Wallace.

The short-term outlook among consumers remains “dismal,” said Lynn Franco, the Conference Board’s senior director of economic indicators.

“Notably, concerns about inflation — which had been receding since July — picked up again, with both gas and food prices serving as main drivers,” Franco said in a statement. “Looking ahead, inflationary pressures will continue to pose strong headwinds to consumer confidence and spending, which could result in a challenging holiday season for retailers.”

Consumers’ levels of optimism dimmed for not only the current economic period but also what could come during the next several months.

That’s not a great economic omen.

The numbers: The consumer confidence index slumped to 102.5 from a revised 107.8 in September, according to data released Tuesday by the Conference Board. Economists were expecting a reading of 106.5, per estimates from Refinitiv. A reading above 100 signals consumers have an optimistic attitude toward the economy. In February 2020, the consumer confidence index was 132.6.

Prices are going up again

Don’t expect things to get cheaper anytime soon. Major food and drink CEOs are issuing warnings of price hikes to come.

Kraft Heinz CEO Miguel Patricio told CNN Business’ Christine Romans in a recent interview that higher inflation and supply issues are coursing through the food industry, prompting his company to continue to increase prices.

“We’ve already increased the prices that we were expecting this year, but I’m predicting that next year, inflation will continue, and as a consequence [we] will have other rounds of price increases,” Patricio said.

On Tuesday, Coca-Cola CEO James Quincey made similar comments. “There’s going to be above normal input costs,” Quincey said on CNBC’s Squawk on the Street. “So we are expecting pricing to be ahead of normal next year on top of what’s happened this year. “

That’s not bad news for Coke, though. Coke’s higher prices helped lift its net revenue 10% in the third quarter.

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