Market Wire - US Economy Contracts in Second Quarter, Markets React by Loosening Financial Conditions

The American economy shrank more than expected in the second quarter, but consumption grew, suggesting that the slowdown has not yet reached levels necessary to declare a recession. Economists and markets were somewhat prepared for a weak print, but the number could generate negative - and self-reinforcing - implications for business and consumer psychology. 

Data released by the Bureau of Economic Analysis this morning showed the economy contracting -0.9 percent in the April-through-June period as fiscal and monetary tightening effects became more entrenched. 

Residential investment subtracted -0.70 percent from the headline growth number, and overall investment cut -2.73 percent. A continued decline in fiscal spending took a -0.33 percent negative toll on overall growth, with net government spending becoming more restrained after several Covid-era splurges. 

Trade played a beneficial role: net exports added 1.43 percent to overall growth - but rising inventories offset this by subtracting -2 percentage points, likely reflecting “bullwhip” effects as distributors and retailers struggled to manage supply chain risks. 

Overall consumer spending grew 1 percent in the quarter, down from a 2.7 percent gain in the prior period as households cut outlays on goods and shifted toward services. 

Real final sales to domestic purchasers - a measure that removes trade and inventories, and is used by economists to estimate the robustness of domestic demand - fell -0.3 percent. 

The personal savings rate - which has been held out as way to measure future spending capacity - fell to 5.2 percent from 5.6 percent in the first quarter, plumbing lows not reached since 2016. 

Tomorrow’s personal income and spending data should provide further insight into the handoff from the second quarter. The Federal Reserve’s favoured wage growth indicator - the Employment Cost Index - could also have significant ramifications for currency markets. 

Treasury yields slumped and the dollar fell as odds were cut on bigger rate hikes from the Federal Reserve this autumn. Commodity prices rose and equity futures strengthened on the prospect of easier financial conditions.