January Surge Kept Q1 Positive

The US economy is being tugged in two different directions right now. On the positive side, we have the lingering effects of the massive stimulus of 2020-21, the renormalization of the service sector after COVID Lockdowns, and, as always, the entrepreneurial and innovative spirit of the American people. On the downside, we have the early stages of a drop in the money supply that started last year and too much government spending.

The problem with forecasting the economy right now is we have never been in this position before, where an unprecedented two-year surge in the money supply (plus massive temporary transfer payments) were closely followed by a dive in the money supply unlike anything we’ve seen in decades.

Eventually, we believe the balance of these forces will tilt the US economy into a recession. However, largely due to a temporary surge in consumer spending in January, Real GDP growth remained positive in the first quarter. As we set out in a Monday Morning Outlook two months ago, January came in strong due to odd factors like unusually warm weather, a big Social Security cost-of-living adjustment, and seasonal-adjustment issues due to the timing of COVID stimulus payments in 2020-21.

As we set out below, we think the economy grew at a 2.3% annual rate in Q1, although we may tweak this forecast slightly in the next ten days based on reports on housing, inventories, and international trade.

In addition, we think the second quarter will likely be weaker than Q1, and very possibly negative. The ISM Manufacturing index has been below 50 for five straight months and, at 46.3, is at a level often (although not always) associated with a recession. Manufacturing production is down 1.1% from a year ago. The ISM Services index is barely north of 50. Continuing unemployment claims are up 37% from six months ago. Retail sales are down in four of the past five months, the lone exception being the January surge.