Construction slowdown, inflation, interest rates and shrinking GDP don’t guarantee recession
By Larry StewartAugust 03, 2022
Initial estimates of a second quarter of receding GDP coming the day after the Federal Reserve announced unprecedented increases in the federal funds rate raised cries of “recession!”
The U.S. Bureau of Economic Analysis recently estimated the economy shrunk in 2022’s second quarter at an annual rate of 0.9%. That’s two quarters in a row of GDP decline.
The day after the report, the Federal Reserve announced a second increase in the federal funds target rate by 0.75% in as many months, increasing the upper boundary of that target to 2.5%. The federal funds rate started 2022 near zero and the July increase, which is not necessarily expected to be the last this year, was the fourth of 2022. June inflation had been clocked at 9.1%, the highest rate since 1981.
Average 30-year-fixed mortgage rates had climbed to briefly exceed 6% in mid-June, according to CNBC. But within hours of the news of the second quarter’s shrinking GDP, mortgage rates turned sharply downward. On Tuesday, Fortune reported the average 30-year fixed rate at 5.05%. Fortune suggests mortgage rates are moving against the federal funds rate because financial markets are pricing in a 2023 recession.
Housing-production estimates from the Department of Commerce showed new housing starts slid 2.0% to a seasonally adjusted annual rate of 1,559,000 units. That follows a 13.5% plunge from April to May.
The economy’s thrill ride continued this week with the Commerce Department’s initial estimates of the value of June construction put in place sliding 1.1% from May. The vast majority of that decline came in a 3.1% fall in spending on single-family housing construction.
Spending on multifamily construction was up 0.4%. Nonresidential construction spending was down 0.5%, with the six largest nonresidential categories all down or flat. Notable nonres declines were 1.7% in the largest category, power construction, and a 2.8% decline in highway and street construction.
“There continues to be significant downward pressure on nonresidential construction spending volumes, and that is likely to intensify going forward,” said Associated Builders and Contractors Chief Economist Anirban Basu. He points out that construction spending has been propped up by rising materials prices and wages.
“The primary issue is that those high construction delivery charges are inducing a significant fraction of project owners to reconsider start dates. True, backlog remains elevated, according to ABC’s Construction Backlog Indicator, but this may be because it is taking longer to complete projects. Additional project delays and cancellations are likely as borrowing costs continue to ratchet higher for those who purchase construction services and as the risk of recession increases. For now, many contractors remain busy and continue to operate at or near capacity. Whether that will continue for another 12 to 18 months remains an unanswered question.”
Economists agree the U.S. economy is slowing from its 5.7% 2021 growth pace, which was its fastest full-year clip since 1984.
The Washington Post reports that the only time there have been six months of GDP contraction without a recession was in 1947. Some consider the Federal Reserve interest rate increases a recessionary shove, but the link between the federal funds rate and recessions may not be urgent.
Yahoo!Finance reports on a Deutsche Bank analysis of 70 years of data on rate increasing cycles that suggests it takes around three years from the first Fed rate hike
to enter a recession.
The quickest recession happened in July 1981, but the numbers then showed some significant differences from today. Inflation had soared in 1980 to 14.6%, its highest level on record, and the federal funds rate began the decade at a target level of 14%. The Fed hiked the target range in early December by 2 percentage points to 19% to 20%, its highest ever. This controlled burn across the economy was intended to head off runaway prices, and the erratic rate changes that followed in the 1980s gave rise to a new conservatism for the Fed in which it strives to avoid surprising markets to prevent undue financial tightening.
Deutsche Bank found that not every Fed hiking cycle leads to a recession, and the longest time span between the first rate hike and recession was 84 months.
It does take more than two quarters of GDP decline to make a U.S. recession. A committee made up of eight economists at the National Bureau of Economic Research determines when we’re in recession based on many indicators, notably unemployment (currently near record lows) and personal income levels (which are in decline).
It’s important remember that the construction industry has been on a remarkable ride when evaluating changes in recent months’ construction numbers in this context. Total construction spending in June was more than 22% higher than its pre-pandemic peak, and 51% greater than the peak before the Great Recession.
Even after a nearly 16% drop in the most recent two months, new housing starts have slipped just 0.5% off their pre-pandemic high, and 15% above the top of the bubble in 2007. The May and June slowdown should draw some attention, but starts also dropped more than 15% from July to September of 2016 and nearly 15% from February to May 2017.