The drumbeat of recession grew louder after the US economy shrank for a second straight quarter, as decades-high inflation undercut consumer spending and Federal Reserve interest rate hikes stymied businesses and housing.

Gross domestic product (GDP) fell at a 0.9 per cent annualised rate after a 1.6 per cent decline in the first 3 months of the year, the Commerce Department’s preliminary estimate showed on Thursday (Jul 28). Personal consumption, the biggest part of the economy, rose at a 1 per cent pace, a deceleration from the prior period.

The median projection in a Bloomberg survey of economists called for a 0.4 per cent advance in GDP and a 1.2 per cent rise in consumer spending.

The report will add to political headaches for President Joe Biden and complicate the Fed’s calculus over how aggressively to raise interest rates.

In addition to the slowdown in household spending, the report also showed that declines in business investment, government outlays and housing. Inventories also weighed on GDP, while a narrower trade deficit added to the figure.

A key gauge of underlying demand that strips out the trade and inventories components — inflation-adjusted final sales to domestic purchasers — fell at a 0.3 per cent pace in the second quarter compared with a 2 per cent gain in the prior period.

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The report illustrates how inflation has undercut Americans’ purchasing power and tighter Fed monetary policy has weakened interest rate-sensitive sectors such as housing. That weakness is likely to throw fuel on an already heated debate about if or when the US enters a recession.

While the common rule of thumb for recessions is 2 consecutive quarterly declines in GDP, the official determination of ends and beginnings of business cycles is made by a group of academics at the National Bureau of Economic Research. 

Two-year Treasury yields tumbled after the report potentially reduced chances of further aggressive Fed rate increases, while US stock futures erased losses and the US dollar fell.

Retailers such as Walmart and Target have slashed their profit forecasts, and a slew of tech companies, including Shopify, have announced plans in recent weeks to cut workers. Others, including Apple and Microsoft, are slowing hiring. 

Broader weakness in a labour market that has shown only limited signs of cooling would remove a key source of support for the economy and help shape the course of monetary policy later this year.

“We think it’s necessary to have growth slow down,” Fed chair Jerome Powell said at a news conference on Wednesday after another 75 basis point hike in interest rates. “We actually think we need a period of growth below potential in order to create some slack so that the supply side can catch up. We also think that there will be, in all likelihood, some softening in labour market conditions.”

According to a separate report on Thursday, applications for unemployment benefits last week were higher than forecast.

The GDP data showed services spending accelerated to a 4.1 per cent annualised rate, though outlays on goods shrank 4.4 per cent. Inflation-adjusted spending data for June will be released on Friday. 

Americans are facing higher prices for virtually everything from petrol to food to rent. Wages have increased but not fast enough to keep pace with inflation, driving consumer sentiment to multi-year lows. The Fed is determined to limit inflationary pressures, some of which are due to factors outside their control — such as Russia’s war in Ukraine. 

Powell said that while more rate increases are forthcoming, the sizes of the moves will be data dependent. Currently, “the labour market is extremely tight, and inflation is much too high”, he said.

Last quarter, inflation-adjusted business investment eased 0.1 per cent, reflecting declines in both spending on structures and equipment. Outlays on intellectual property products rose solidly.

Residential investment plunged at a 14 per cent annual pace, the largest decline since the start of the pandemic and reflective of how high borrowing costs along with rapid inflation have squeezed the housing market. Sales have been falling for months, and builders are increasingly downbeat about future demand.  

The report showed trade added 1.43 percentage points to the per cent change in GDP, while the change in inventories subtracted 2 percentage points.

The personal consumption expenditures price index, an inflation measure followed by Fed officials, grew an annualised 7.1 per cent for a second quarter. Stripping out food and energy, the index rose 4.4 per cent after rising 5.2 per cent. Bloomberg