Numbers That Matter: Plastics feeling a pinch but may avoid recession

A funny thing happened on the way to the recession. According to the advance estimate recently released by the Bureau of Economic Analysis, real GDP in the U.S. increased at an annual rate of 2.4 percent in the second quarter of 2023. In the first quarter, real GDP expanded 2.0 percent.

This advance estimate will be revised a couple of times in the coming weeks, so it is possible the total GDP actually grew a bit slower — or faster — than what was recently reported. But the revisions will likely not be large, so the key point is that the U.S. economy actually expanded by about 2 percent in the first half of this year after adjusting for inflation. And future revisions notwithstanding, the pace of growth quite likely accelerated in the second quarter.

The funny thing about all of this is that it was not supposed to happen. Economists and analysts of every ilk spent most of last year debating whether the Fed's aggressive campaign of raising interest rates in an effort to curtail inflation would push the U.S. economy into an outright recession.

You will recall this debate generated a lot of speculation on one side about the severity of the pending recession and the prospects of a "soft landing" on the other. At that time, I don't think there was ever a strong consensus on the depth of the coming slowdown. But given the timing and the intensity of the Fed's tightening program, I think most analysts expected we would start to see the effects of higher interest rates in the GDP data by the middle of 2023.

Fast forward to now, the middle of the third quarter of 2023. The stock market is up a tidy 16 percent for the year to date, the rate of inflation has recently been clocked at about 3 percent, the unemployment rate is a stellar 3.5 percent, and the gravity-defying pace of growth in the overall economy just ticked up a notch to 2.4 percent. This may not be nirvana, but these numbers sure seem pretty good.

That's what makes it funny to me. I defy anybody to go back a year ago and find a published forecast that predicted the economic data would be anywhere close to where it is now. Regular readers of this column will recall I never bought into the "recession is imminent" narrative, but I did expect the pace of overall growth to get down below 1 percent for a quarter or two.

I thought there was a strong probability that some sectors of the economy would experience a significant contraction, nevertheless, I thought the chances of avoiding an overall recession might be in the range of 50-50 or perhaps a bit better. Therefore, I must admit that after 16 months of interest rate hikes, totaling an astonishing 5.25 percentage points, I am surprised to see that recent trends suggest economic growth might actually be … strengthening? In fact, I am extremely surprised.

It could be argued that this is a "happy" surprise and that maybe this will all work out better than anyone expected. But as a lifelong disciple of the dismal science, I do not like surprises — even good ones.

A deeper dive into the GDP data is always enlightening. The long-term trends in the data from the plastics industry closely align with the trends in the overall economy. And, by far, the most important part in the GDP report is the data on personal consumption expenditures, especially the PCE for goods. Most plastics products are used in either durable or nondurable goods sold to consumers, so the trends in total PCE for goods are great indicators of future demand for plastic products.

And contrary to the trend in the headline GDP data, the trend in the PCE data for goods decelerated markedly in the second quarter. After expanding at an annualized rate of 6 percent in the first quarter, total consumer spending on goods slowed to a gain of only 0.7 percent in the second quarter. Breaking the data down further, spending for durable goods grew by 0.4 percent in the second quarter after posting a gain of 16.3 percent in Q1. And spending on nondurables grew by 0.9 percent in Q2, which is a moderate gain from the 0.5 percent growth the previous quarter.

The key takeaway from all of this is that, despite a tick upward in the headline GDP reading, the trends in the consumer spending segment of the data are decelerating. And the recent growth rate in the crucial PCE data for goods is well below 1 percent. As I mentioned earlier, when the growth rate is at that level, there is a good chance that some of the industries in that sector are experiencing a contraction.

These figures from the PCE data align much more closely with what I observe in the data from the plastics industry. And while I am surprised by the headline GDP number, the trends in the underlying consumer spending data are quite close to what I expected. So, what's next?

My latest outlook calls for the trend in the overall GDP data to decelerate over the next three or four quarters. The data may have surprised us so far this year, but the reality is that higher interest rates are intended to constrain demand, and eventually this will happen.

Trends in consumer spending drive the trends in the overall economy, and it is clear overall consumer spending is decelerating. It may even contract for some types of goods and services. Of course, this will negatively affect demand for many types of plastic products if it has not done so already.

Due to the resilience of the labor market — and also the strong upward trends in business investment for both structures and equipment — I do not expect the overall economy to enter into an officially designated recession. In fact, I think the chances of avoiding a recession have improved since last year. But I cannot take the risk of recession completely off the table. I have learned to expect surprises.