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Worsening business activity data is 'setting the scene' for an economic contraction this year

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The U.S. economy is showing more signs of deterioration.

The preliminary S&P Global Composite Purchasing Managers' Index (PMI) for June came in at 51.2, the weakest level since January, when Omicron-related disruptions were still weighing on growth. This was also the second-weakest reading for the index since the height of the pandemic in mid-2020. Consensus economists were looking for a print of 53.0, according to Bloomberg data, following May's final reading of 53.6. Levels above 50.0 indicate expansion in the economy.

"The pace of U.S. economic growth has slowed sharply in June, with deteriorating forward-looking indicators setting the scene for an economic contraction in the third quarter," Chris Williamson, chief business economist at S&P Global Market Intelligence, said Thursday. "The survey data are consistent with the economy expanding at an annualized rate of less than 1% in June, with the goods-producing sector already in decline and the vast service sector slowing sharply."

Beneath the headline figure, both the services and manufacturing indexes registered month-on-month declines. The services PMI weakened to a five-month low of 51.6 in early June from May's 53.4 as a deceleration in new orders and rising costs stifled growth in the sector.

A worker carries a piece of rebar at the World Trade Center transportation hub in New York May 6, 2013.  REUTERS/Eric Thayer
A worker carries a piece of rebar at the World Trade Center transportation hub in New York City on May 6, 2013. REUTERS/Eric Thayer

The manufacturing PMI registered an even larger decline, falling to 52.4 from May's 57.0 as the manufacturing output index slid into contractionary territory of 49.6 for 24-month low. Worse declines were only registered twice before in the 15-year history of the data — early on during the pandemic lockdowns of 2020, and at the height of the 2008 global financial crisis.

“Businesses have become much more concerned about the outlook as a result of the rising cost of living and drop in demand, as well as the increasingly aggressive interest rate path outlined by the Federal Reserve and the concomitant deterioration in broader financial conditions," Williamson added. "Business confidence is now at a level which would typically herald an economic downturn, adding to the risk of recession."

The report follows comments from key Federal Reserve officials, who have increasingly begun to acknowledge the risk of a recession as they work to address inflation by raising interest rates and tightening financial conditions this year. Fed Chair Jerome Powell told the Senate Banking Committee on Wednesday that it was "certainly a possibility" that the U.S. economy could slip into a recession, while underscoring it was not the central bank's "intended outcome."

Others struck a similar tone.

“We could have a couple of negative quarters" of economic growth, Philadelphia Fed President Patrick Harker told Yahoo Finance in an interview Wednesday.

The definition of a “recession” is commonly referred to by investors as two back-to-back quarters of negative economic growth. The first quarter of 2022 already saw a real GDP contraction of 1.5% on an annualized basis. An initial reading on second quarter growth is due at the end of July.

The National Bureau of Economic Research, which is in charge of “dating” recessions, clarifies that they look beyond real GDP figures when declaring a recession. The NBER looks at real income, employment, among other economic variables.

Amid the souring in some economic data and the Fed's ongoing rate hiking path, a number of Wall Street banks have also warned that risks of a recession have mounted. Deutsche Bank, which has maintained for months that the U.S. economy is headed for a recession, said it now expects the formal downturn to begin in the third quarter of 2023. Goldman Sachs economists now see a 30% probability that the U.S. economy enters a recession over the next year, up from a 15% risk seen previously.

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