US Q2 GDP contracts by 0.6%, but lower than estimated

In any macro level policy analysis, there are two factors that matter. The first is inflation and the US inflation is something most traders are tracking. Equally important is the US quarterly GDP growth, which is normally given less weightage, but has larger ramifications for India. On 25th August, the US Bureau of Economic Analysis (BEA) published the second estimate of the US GDP for the June 2022 quarter. The US Real GDP contracted by -0.6% in the June quarter, but this contraction is lower than the first estimate of -0.9%. That is good news. 

While imports and lower retail inventory put pressure on the quarterly GDP, that was partially mitigated by improved export of travel services as well as a surge in consumer spending. In this case, the surge in consumer spending reflects the surge in demand for food and accommodation services. That explains, quite eloquently, why the eventual contraction in GDP for the June 2022 quarter was 30 bps lower than the first estimate and 100 bps lower than the Q1 Real GDP contraction of -1.6%. This would count as an improved show.

It is inflation that hit real GDP hard

From the beginning, the Fed has held on to two opinions. Firstly, the Fed believed that consumption was a better gauge of growth than manufacturing output. Secondly, the Fed also believed that the difference between expansion and contraction of GDP lay in inflation. Here are some interesting data points to underscore this view.

    a) The nominal GDP (before considering inflation) was up 8.4%, with annualized nominal GDP at approximately $24.88 trillion for FY22. Unfortunately, the entire nominal GDP growth was offset by high levels of inflation, which resulted in contraction in real GDP. That is one of the reasons, the Fed believes that the GDP story will predicate on inflation control, more than anything else.

    b) The Fed does not only look at consumer inflation but also at private consumption expenditure (PCE) driven inflation. For Q2, that has bene static at 7.1% while the core PCE inflation (net of food and energy inflation has been static at 4.4%. what this means is that even as consumer inflation is falling, the PCE inflation is still just about flat. 

    c) Fed has always harped on personal incomes and the current dollar personal incomes increased by $353 billion in Q2. The lag effect of COVID spending still continues. Also, the corporate profits have been robust in Q2 compared to a tepid performance shown in Q1. In short, monetary tightening is yet to impact consumption.

This broadly explains why the Fed would not easily give up on its obsession with inflation control.

Where does Jerome Powell go from here and the India Impact

Currently, all eyes are rivetted on Jerome Powell’s speech at the Jackson Hole Symposium over the weekend. This is the high profile gathering of global central bankers and some of the finest academicians in the world to deliberate and brainstorm on policy matters. Fed has been emphatic that the key decision point would still be inflation and that that is unlikely to change after the encouraging GDP numbers (lower than expected contraction is good). That means, the Fed is still going to front load rate hikes and even touch 3.75% in 2022 itself.

What does this mean for India Inc? There is a positive and a cautionary angle to this. Firstly, the GDP growth (nominal) shows that the US economy is still strong and tech spending by big corporates is unlikely to be impacted. Secondly, it looks like the RBI would not stop at 5.4% if the Fed sustains its hawkish stance. The RBI may have to prepare the markets for more rate hikes, possibly a terminal repo rate of closer to 6.5%. After all, if inflation comes down, then most of the macro problems get resolved automatically for India.