The US economy has yet to face its biggest recession challenge

A person removes the nozzle from a pump at a gas station on July 29, 2022 in Arlington, Virginia.

Olivier Douliery | AFP | Getty Images

You would be hard-pressed to find a rearview mirror recession right now. What’s on the road, however, is a different story.

There is no historical precedent indicating that an economy in recession can produce 528,000 jobs in a month, as the US did in July. An unemployment rate of 3.5%, the lowest since 1969, is not consistent with contraction.

But that doesn’t mean a recession isn’t on the horizon, and ironically, it’s the phenomenal resilience of the labor market that could pose the greatest danger to the economy in the long run. The Federal Reserve is trying to ease pressure on a historically tight job situation and its rapid wage increases in an effort to contain inflation that is at its highest level in more than 40 years.

“The fact is, this gives the Fed additional room to continue tightening even if it increases the likelihood of the economy slipping into recession,” said Jim Baird, chief investment officer at Plante Moran Financial Advisors. “It will not be an easy task to continue tightening without negative consequences for consumers and the economy.”

Indeed, after robust jobs data, including a 5.2% 12-month gain for hourly wages, traders accelerated their bets on a more aggressive Fed. As of Friday afternoon, markets gave a roughly 69% chance that the Fed would make its third consecutive 0.75 percentage point rate hike when it reconvenes in September, according to data from the CME Group.

So while President Joe Biden celebrated the big job number on Friday, a much more unpleasant data point could be coming next week. The consumer price index, the most widely followed inflation measure, is due out on Wednesday and is expected to show continued upward pressure, even with gasoline prices falling sharply in July.

That will put pressure on the Fed’s balancing act to use rate hikes to dampen inflation without sending the economy into recession. As Rick Rieder, chief investment officer of global fixed income at asset management giant BlackRock put it, the challenge is “how to execute a ‘soft landing’ when the economy picks up steam and lands on a runway that has never been used before.”

“Today’s pressures, coming in much stronger than expected, complicate the task of a Federal Reserve trying to create a more subdued employment environment, consistent with its efforts to moderate current inflation levels,” Rieder said in a client note. “However, the question now is how long (and higher) do interest rates have to go before inflation can be brought under control?”

More signs of recession

The financial markets are betting against the Fed in other ways.

The yield on 2-year Treasuries surpassed that of the 10-year bill with the highest margin in about 22 years on Friday afternoon. That phenomenon, known as an inverted yield curve, is a telltale sign of a recession, especially when it lasts for an extended period of time. In the present case, the inversion has been in effect since early July.

But that doesn’t mean a recession is imminent, just that it is likely to be in the next two years. While that means the Fed has time, it could also mean that the central bank doesn’t have the luxury of slow rate hikes, but rather needs to act fast – a situation policymakers had hoped to avoid.

“This is certainly not my base case, but I think we might start hearing some chatter about a rise in meetings, but only if the next batch of inflation reports is hot,” said Liz Ann Sonders, chief investment strategist at Charles. Schwab.

Sonders called the current situation “a unique cycle” in which demand shifts back to goods services and poses multiple challenges to the economy, making the debate about whether the US is in a recession less important than what’s going on. lies ahead.

That’s a widely held view of economists, who fear the hardest part of the journey is yet to come.

“While economic output contracted for two consecutive quarters in the first half of 2022, a strong labor market means we are unlikely to be in a recession right now,” said Frank Steemers, senior economist at The Conference Board. “But economic activity is expected to cool further towards the end of the year and it is increasingly likely that the US economy will enter recession before the end of the year or early 2023.”

Leave a Comment