The US economy on Wednesday reported a contraction in real GDP of 0.3 per cent for Q1 of 2025, compared with the preceding quarter. This comes on the back of surging imports and rising prices.
Companies such as General Motors, UPS and Delta Airlines have either withdrawn or refrained from giving earnings guidance. Such soft indicators sure point towards a slowdown unravelling. Also, with the PCE index (personal consumption expenditure index – measures consumer inflation) for Q1 rising 3.6 per cent, the highest since Q1 2023, does that mean the US is headed for a stagflation – a period characterised by receding economic activity caused by elevated prices? Global financial bellwethers, the likes of JP Morgan and Goldman Sachs do think so, with their probability of recession ranging anywhere between 25 per cent and 60 per cent. Ask prediction market Kalshi, and it says a 62 per cent chance of a recession this year.
While recessions have not been good for the equity markets in the past, including India, here’s a low-down on US recession and what the contraction means to global equities.
What is GDP? What does the contraction in Q1 actually mean?
GDP or Gross Domestic Product measures the market value of the goods and services produced by a nation’s economy in a particular period. There are two ways of calculating GDP – the income approach and the expenditure approach. The Bureau of Economic Analysis (BEA) of the US Department of Commerce is the entity tasked with measuring US’ GDP, and it follows the latter approach .
Under this approach, GDP is measured as the sum of expenditure or purchases by final users and is illustrated by the formula – C + I + G + (X – M), where C denotes consumption expenditure by households, I stands for investment expenditure by businesses, G represents government spending, X is exports of goods and services, and M is imports.
The BEA calculates GDP for every quarter with this formula (also adjusted for seasonality and annualised) and reports an expansion or contraction with respect to the GDP recorded for the preceding quarter.
As far as Q1 2025 is concerned, the contraction of 0.3 per cent is as a result of an increase in imports (M) and decrease in government spending (G), only partly offset by an increase in consumer spending (C) and investment expenditure (I).
Based on Q1 GDP data, has the US economy entered a recessionary phase?
The GDP number is a result of a grand estimate of the economic activity during a specific period. The data points used in the exercise come at different frequencies or intervals and hence warrant repeated revisions to the estimates made earlier.
‘Advance’ or current quarterly estimates are released near the end of the first month after the end of a quarter. Revised estimates are released at the end of each of the following two months and referred to as ‘second’ and ‘third’ quarterly estimates. In addition to this, quarterly estimates undergo another round of revision when annual estimate of GDP for the financial year as a whole, take place in July typically (US follows the calendar year). Such annual estimates are also subject to multiple revisions.
For example, the advance estimates for Q4 2008 revealed a contraction of 3.8 per cent. But it later turned out to be an even bigger contraction of 8.5 per cent, after the final revision.
Therefore, the 0.3 per cent contraction in Q1 2025 GDP, is just an advance estimate that can undergo multiple revisions going forward. The revisions might reveal a bigger contraction or even an expansion over Q4 2024. Hence, it would be too soon to conclude that the US economy has entered a recessionary phase.
What exactly is a recession in the US?
While technically a recession is defined as two consecutive quarters of contraction in economic activity, the definition of a recession is different, in so far as the US is concerned. In the US, it is the BCDC (Business Cycle Dating Committee) of the NBER (National Bureau of Economic Research) that calls out whether a recession has happened or not.
The BCDC maintains a chronology of business cycles – expansions (the period between a trough and a peak) and recessions (the period between a peak and a trough). Expansion, in other words, is a period when the economy is not in a recession.
The NBER follows a flexible, principle-based approach to pronounce a period as recessionary. Its definition of recession involves a significant decline in economic activity that is spread across the economy and lasts more than a few months. Per the BCDC, three criteria emerge on interpretation of this definition – depth, diffusion and duration. While each criterion needs to be met individually to some degree, extreme conditions revealed by one criterion may partially offset weaker indications from another, in certain instances.
For example, in the case of the February 2020 (pandemic year), the BCDC concluded that the subsequent drop in activity had been so great and so widely diffused throughout the economy that, even if it proved to be quite brief (from March 2020 to April 2020), the downturn should be classified as a recession.
What indicators does the BCDC use to determine peaks and troughs?
The BCDC uses a range of monthly measures of aggregate economic activity published by federal statistical agencies. These include real personal income less transfers (transfers here mean social security benefits, unemployment insurance, medicare/ medicaid payments an individual receives from the government), nonfarm payroll employment, real PCE, industrial output and trade sales adjusted for price changes. However, the two measures that have assumed the most weight in recent decades are real personal income less transfers and nonfarm payroll employment.
How long does it take for the BCDC to declare a recession?
Unlike GDP estimates which go through multiple revisions, the BCDC doesn’t often reverse its position after determining a period as recessionary. Hence, there is a wait for sufficient quality data involved, such that the BCDC is confident enough to identify a peak or a trough. There is also no timing rule that binds the committee.
For example, the peak observed before the Covid-induced slowdown was determined by the committee only on June 8, 2020, and the trough in April 2020 that followed the peak was confirmed only on July 19, 2021.
How have equities performed in recessions?
Equity markets, of course, do not wait until the NBER makes a call and will react to all the leading indicators that point to a recession. Just like your body wouldn’t wait to react to a viral infection until the doctor diagnoses it.
The NBER has flagged 12 recessions since World War II. Equity returns during such periods are summarised (with available data) in the infographic.
Drawdowns in major indices have ranged anywhere between 15 per cent and 80 per cent. Recessions in the US have affected Indian equities too and the Sensex drawdowns during the last four US recessions have been (earliest recessions first) 39 per cent, 58 per cent, 54 per cent and 40 per cent respectively and in some cases have been deeper than the ones in US indices.
Various theories are making the rounds that suggest Indian markets are decoupled and will be immune to a US recession. If one were to go by what history has taught, it would be prudent to not brush aside the possibility of a deep drawdown and take guard with smart asset allocation.
Published on May 3, 2025