US Q2 GDP Beats Expectations, the Market No Longer Anticipates Recession

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In July, the U.S. economic cycle remained in the slow growth quadrant. Based on the latest advance estimate that real GDP grew at a year-on-year rate of 2.6% in the second quarter (prior: 1.8%), this demonstrates that the U.S. economy still shows resilience, the market has further revised up growth forecast for the rest of the year. Atlanta Fed's GDP Nowcast for Q3 has risen to 3.9%. Additionally, during the latest FOMC press conference, Fed Chair Powell mentioned that Fed economists no longer predict a mild recession later this year.

In the following, we summarize two key takeaways from the latest U.S. economic prints:

1. With Q2 GDP growing at 2.6% YoY, the market no longer expects a recession

Q2 GDP figures released on July 27 showed that real GDP rose at a QoQ annualized rate of 2.4% (prior: 2%) and a year-on-year rate of 2.6% (prior: 1.8%), far surpassing market expectations. Looking at individual GDP components, we expect growth to be sustained by three drivers in the second half of 2023:

Manufacturers to replenish inventories:

Despite a substantial increase in private investment in Q2, changes in inventories only contributed to a modest 0.14% in the percent change in GDP. Since the second half of 2022, the manufacturing sector has been actively reducing inventory levels, with June’s ISM Manufacturing Inventories Index dropping to as low as 44 and Customers’ Inventories falling steeply to 46.2 (prior: 51.4). Based on these developments, we expect the manufacturing sector to complete inventory destocking in Q3, which will set the stage for restarting an upward cycle.

Sustained momentum in consumer spending:

Consumer spending increased by 2.3% year-over-year in the second quarter, showcasing resilience. As workers’ wages and salaries reached $14.17 trillion (prior: $13.99 trillion), and disposable personal income and savings rising to $19.86 trillion (prior: $19.61 trillion) and $869.5 billion (prior: $840.9 billion), respectively, a robust labor market is set to sustain the momentum in consumer spending.

Rebounding private investment:

Driven by policy initiatives, increased investment in computing and electronic manufacturing facilities in the Southwest has fueled nonresidential fixed investment to grow at an annual rate of 4.6%. Meanwhile, on the housing front, both new home sales and existing home sales have stabilized during the first half of the year. With persistently low inventory of existing homes and inventory of new homes for sale down from its peak, alongside the winding down of interest rate hikes in the second half of the year and lower base figures for residential investment, negative year-on-year growth in residential investment is expected to abate as well.

2. Core inflation continues to ease, outlook for rate hikes to end unchanged

The market remains concerned that goods inflation could still persist in the second half of the year. Based on the Consumer Price Index (CPI) data for June, gradually lower bases for YoY increase in energy prices do provide a chance for energy’s negative contribution to narrow. Nevertheless, the possibility of a significant resurgence in core inflation remains low with both new car and used car prices posting month-over-month declines.

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