US economy powers ahead, boosting chances of averting recession

The US economy shined in its latest report card, supporting calls that it can dodge recession despite the most aggressive interest-rate hikes in a generation.

Gross domestic product advanced in the second quarter by more than most economists’ estimates, buoyed by resilient consumer spending and robust business investment. Even so, price pressures still cooled, with underlying inflation rising at the slowest pace in more than two years.

Combined with other data Thursday that showed stronger-than-expected orders for business equipment and fewer applications for unemployment benefits, the GDP figures bolster the case that the Federal Reserve can tame inflation without putting millions of people out of work.

It also risks supporting another Fed rate hike after the central bank lifted borrowing costs to the highest level in 22 years on Wednesday and left the door open for more.

“While economists remain divided on the probability of recession at present, today’s report raises the odds of a soft landing,” Wells Fargo & Co. economists Tim Quinlan and Shannon Seery said in a note. “That said, it likely also keeps the heat somewhat turned up on the Fed.”

Treasury yields rose after the report. Fed Chair Jerome Powell, speaking in a press conference after the central bank’s latest move, said policymakers could go either way with another hike or holding steady depending on what the data show in the next eight weeks.

He also said the central bank staff is no longer forecasting a recession. Similarly, some Wall Street economists are beginning to reassess the timing or odds of a downturn.

What officials would like to see, however, is below-trend growth, and the GDP report may be too strong for comfort. Despite a rapid ascent in interest rates since early 2022, consumers and businesses are still spending with vigor so far this year.

Consumer spending — the engine of the US economy — increased at a 1.6% pace after surging at the start of the year, the Commerce Department’s initial estimate showed Thursday. The latest print was more than forecast and reflected solid outlays on both goods and services.

One caveat of the report was consumer spending on food services and accommodations subtracted the most from GDP since the second quarter of 2020.

More remarkable was spending by businesses. Investment in structures continued to grow at a breakneck pace, bolstered by recent efforts to shore up domestic factory production. The Biden administration championed a series of bills that provide both direct funding and tax incentives for private companies to invest in areas like semiconductors and electric vehicles.

“The biggest surprise to me was the business sector strength, which seems to be driven by implementation” of legislation like the CHIPS Act and Inflation Reduction Act, said Yelena Shulyatyeva, senior US economist at BNP Paribas.

Purchases of business equipment bounded ahead at the fastest pace in more than a year, largely due to stronger spending on transportation equipment such as aircraft and vehicles.

A separate government report on factory orders showed stronger-than-expected bookings of business equipment. Orders for all types of durable goods rose 4.7% in June, the most in nearly three years and fueled by bookings for commercial aircraft.

What Bloomberg Economics Says…

“The second quarter’s accelerated GDP growth reflects an economic force working against the Fed’s efforts to reduce inflation – expansionary fiscal policy… If the recession we predict this year is delayed rather than averted, and the Fed ultimately has to hike more than we currently anticipate — the most likely culprit will be Bidenomics.”

— Anna Wong, economist

The quarterly spending and inflation figures precede Friday’s release of June data, which will provide an indication of economic momentum ahead of the third quarter. Economists expect a pickup in real consumer outlays and the slowest annual inflation rate in more than two years.

Those are the ingredients of a soft landing, especially with jobless claims dropping to the lowest levels since early this year. However, it’s a delicate balance for the Fed to strike to ensure that stronger growth doesn’t reignite price pressures.

“This is the closest we’ve come to a Goldilocks scenario since the onset of the pandemic,” said Diane Swonk, chief economist at KPMG LLP in Chicago. “What the Fed has to worry about is whether or not there will be a later rebound in inflation.”

– By Molly Smith and Reade Pickert with assistance from Steve Matthews. (Bloomberg News)