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Real GDP Increases, but Real GDI Declines in Q1 2023. German Economy In Technical Recession.
Corporate Profits Drop
US GDP & US GDI
The US economy expanded by 1.3% in the first quarter of 2023, as per the latest estimate released by the Bureau of Economic Analysis (BEA). This is a slight increase from the initial estimate of 1.1%. The growth can be attributed to various factors including higher consumer spending, exports, government spending at both federal and state levels, and nonresidential investments.
In contrast, Real gross domestic income (GDI) experienced a decline of 2.3% in Q1, compared to a 3.3% decline in the previous quarter (Q4 2022). To evaluate economic activity, the BEA combines real GDP and real GDI, using an average measure that assigns equal weight to both. This average figure decreased by 0.5% in Q1, compared to a 0.4% decrease in Q4 2022. The BEA's discussion of this average is relevant because it is the input used by the National Bureau of Economic Research (NBER) to determine recessions.
The NBER staff uses various factors like the severity, length, and widespread impact of economic decline to determine if a recession is happening. Typically, a recession is defined as two consecutive quarters of economic decline. While the inverted yield curve is often mentioned as a sign of an upcoming recession, it doesn't directly cause a recession itself.
In the first quarter of this year (Q1), Corporate profits from current production fell at an annual rate of minus 19% compared to the previous quarter. This indicates that businesses are reluctant to hire new employees and increase wages. Corporate profits from current production declined by $151.1 billion, which is a larger decrease compared to the previous quarter's decrease of $60.5 billion in Q4 2022. Domestic nonfinancial corporations saw their profits decrease by $109.3 billion, while rest-of-the-world profits (net) decreased by $16.4 billion, contrasting with a previous increase of $21.4 billion.
This ongoing decline in corporate profits and business performance is prompting companies to make adjustments and closely examine their costs. The persistence of negative factors in the current and future economy makes it less likely for a rebound later in the year.
Current State Of US Businesses
In the US, business activity increased to a 13-month high in May, driven by strong growth in the services sector. The S&P Global's flash U.S. Composite PMI Output Index rose to a reading of 54.5 this month, the highest level since April 2022, and followed a final reading of 53.4 in April. The upbeat reports prompted the Atlanta Federal Reserve to raise its second-quarter gross domestic product estimate to a 2.9% annualized rate from a 2.6% pace.
In contrast to this, corporate bankruptcies are on the rise, with more than 230 companies filing for bankruptcy through the end of April, more than double the comparable figure a year ago. Retail companies are some of the hardest hit in the current economic environment because they are susceptible to consumer buying changes. Companies with weaker balance sheets may continue to feel the pain all the way into next year. The corporate default rate for companies with lower credit quality will peak in early 2024, said Moody’s Investors Service, before falling as economic growth re-accelerates.
US companies are rushing to borrow money in the bond market. 56 companies have priced investment-grade US bond deals in May, with more than two-thirds of the proceeds earmarked primarily for acquisition financing, the highest proportion since December 2021. Highly rated companies have issued bonds worth $112bn so far this month, up from $46bn in May 2022 and more than triple the amount sold in April. May corporate issuance this year is the highest in seven years, excluding 2020, when ultra-low interest rates sparked a $196bn borrowing frenzy. Bankers who handle corporate bond deals say borrowers are making the most of a relatively buoyant market environment to tap investors now before any possible volatility erupts.
Pharma group Pfizer on Tuesday launched a jumbo-sized $31bn bond sale, implemented to help fund its purchase of Seagen. Bankers and analysts pointed out that high-yield, lowly rated companies were generally more focused on credit conditions and tend to tap capital markets less frequently than their investment-grade counterparts. Economic uncertainty in the form of classic recessionary headwinds is what's pushing issuers earlier in the year. The investment-grade market in the US is incredibly resilient, and for the right names, there will always be an audience.
German Economy In Technical Recession
The German economy, which was expected to avoid a recession, has in fact experienced a substantial contraction in output. The data from the Federal Statistical Office showed a second quarter of contraction. The standard definition of a recession is two consecutive quarters of declining GDP. GDP for Q1 fell by 0.3% when adjusted for price and calendar effects, following a 0.5% contraction at the end of 2022.
Persistently high prices continue to be a burden on the German economy, with household consumption down 1.2% in the first quarter of 2023 after seasonal and calendar adjustments. Government spending also declined by 4.9% compared with the previous quarter. A separate Bundesbank report published on May 24 struck a more optimistic tone, with officials suggesting the economy will grow modestly in the second quarter in part due to a rebound in industry, which will offset stagnating household consumption and a slump in construction. The revised GDP figure of -.3% raised fears that Europe's largest economy will suffer a sustained recession.
German companies are also becoming more pessimistic about the year ahead, with the Ifo Institute's index of business confidence falling in May for the first time in seven months. The IMF predicts that Germany will be the weakest performer among the world's big economies this year, with output shrinking by 0.1%.
Why Does the German Economy Matter?
Germany is the fourth-largest economy in the world and the largest in Europe. It is a major exporter of goods and services, with a highly skilled workforce and a strong manufacturing sector. Germany is a key player in the European Union, which is the world's largest trading bloc. As a member of the EU, Germany has access to a large market of over 500 million consumers. Germany is a major investor in other countries, particularly in Europe. German companies have also invested heavily in other European countries, creating jobs and driving economic growth.
Global Economic Deflation
The global economy is currently experiencing a deflationary recession, as evidenced by falling commodity prices, producer prices, and services prices. This recession is not limited to the United States but is a globally synchronized phenomenon. Yield curve inversions have historically been a reliable predictor of economic conditions, but the reasons for this are not fully understood. While some economists attribute yield curve inversions to monetary policy, others believe that there are underlying conditions in the monetary system itself that contribute to these inversions. Regardless of the cause, yield curve inversions are a clear indication that there is more going on in the economy than just central banks raising interest rates. China’s reopening has not lifted the global economy and Germany is already in a technical recession. Sentiment indicators that had turned positive are now turning negative. The ZEW measure of commercial sentiment has faded back to minus 10.7 as of May, and the IFO business climate index has also started to roll over.
Fed Survey Data Shows American Financial Health Is Down
New data from the Federal Reserve has shown that Americans' financial health has deteriorated sharply in 2022 due to elevated inflation. According to a survey published by the US central bank, the share of US adults reporting that they were doing at least OK financially fell to 73%, down 5 percentage points from the previous year and one of the lowest readings since 2016. Nearly 1/3 reported they were either just getting by or finding it difficult to get by. The decline in sentiment has come as the Fed has embarked on its fastest monetary tightening campaign in decades to fight stubbornly high inflation. The Fed's survey indicated that fewer Americans reported being able to cover an unexpected $400 expense using cash, savings, or a credit card that could be immediately paid off, with only 63% answering in the affirmative compared with 68% the year before. Just over 10% said they would not be able to cover the expense by any means. Moreover, 18% said the largest expense they could cover with savings was under $100. Another 14% said their limit was $499.
The decline in financial health is primarily due to unrelenting price pressures causing consumers to either stop buying certain items or switch to cheaper alternatives, and forcing them to dip into their savings. This has led to a credit crunch, as lenders have pulled back in the wake of multiple bank failures since March.
Banks’ tightening lending standards will starve firms and households of credit and help push the economy into recession in the second half of this year. The less lending that banks do, the more likely that various firms are to cut back on investment, which, in turn, slows the growth of employment and the economy overall.
Jay Powell, the Fed chair, cited this on Friday as he hinted he might prefer to skip another rate rise at the June meeting. Many of members of the US Federal Reserve is considering further tightening at the next policy meeting in mid-June as policymakers are concerned that there has been limited progress in getting inflation down. The Federal Reserve staff forecasts suggest that there will be a recession occurring this calendar year.
For more analysis on these topics, check out these articles:
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