Economic pundits, markets and the media are in collective freakout mode, resurrecting the ‘R’ word: recession. US unemployment jumped from 4.1% in June to 4.3% in July, while payroll gains of 114,000 underperformed expectations of around 175,000. Concurrently, stocks capped off a bad week, for the overextended NASDAQ in particular, and the sell-off is continuing in reaction to the unemployment report and unwinding of large global carry trades.
Media and analysts thundered. Reactions included: a recession is not off the table; recession fears are being fanned; recession probabilities are deepening; the Sahm Rule recession threshold has been triggered.
It seems as if only a month ago, the dominant public narrative was that inflation was too high, sticky and far above the Federal Reserve’s 2% target. Services and shelter prices were a trouble spot, food prices were elevated and public opinion polls were finding that – with elections approaching – the scourge of inflation was the number one US economic challenge and threat.
Prior to the employment report, many economists felt the Fed was on the verge of accomplishing a major success, engineering a Goldilocks soft landing.
Now, alongside the recession headlines, renewed Fed bashing has emerged – the Fed is seizing defeat from the jaws of victory. Long pilloried for being too slow to tighten and not having been tough enough in the fight against inflation, the Fed seemingly overnight is now being pilloried by armchair quarterbacks and second guessers as behind the curve, too restrictive and slow to move.
Further, somehow in the 180-degree flip from inflation to recession fears, the American public missed out on being informed that inflation was no longer a central worry. While reports to that effect might have made for boring copy – and there were some to be fair – it hadn’t yet sunk into the American psyche that key inflation measures had declined to 2.5% year over year and are poised to moderate, partly because services and shelter prices are easing.
There is no doubt that July data are pointing to softness, some indicators sharper than others. But the soft landing story should remain the base case for now, though one shouldn’t discount recession concerns and must always prepare for downside risks.
The New York Fed nowcast is projecting Q3 growth of 2.1% at a seasonally adjusted annual rate. The Atlanta Fed nowcast predicts 2.5%. The July S&P composite purchasing managers index was up, buoyed by services. June industrial production and capacity utilisation were solidly up. Torston Slok, Apollo’s chief economist, observes that many real-time consumption indicators (air travel, retail sales) show no signs of a slowdown. Labour market conditions are still strong in that unemployment, even at 4.3%, is highly favourable by US historical standards (Figure 1).
To be sure, key voices, such as William Dudley, former New York Fed president, called for easing at the July Federal Open Market Committee meeting. But many of the newer criticisms of the Fed are excessive. The Fed didn’t have the employment data when the FOMC met.
Further, after having been pilloried for so long over inflation, and against the electoral backdrop with comments from candidate Donald Trump, the FOMC would understandably want a fully convincing case that could command a strong committee consensus before cutting rates. Committees rarely exhibit dexterity, except under duress.
One month’s data don’t make a trend. Some analysts have argued that weather-related events may have impacted the outcome. Further, there are debates about whether the labour market’s softening is being impacted by expanded labour supply dynamics or a fall in labour demand. The latter would be a more deleterious signal for the economy, while the former might suggest the labour market and underlying economic health remain more solid than suggested by the rise in the unemployment rate.
There are also many moving pieces in the economy. Markets are already discounting a series of Fed rate cuts over the remainder of the year and into 2025. Thus, even though the FOMC left the Fed Funds rate unchanged, market rates have fallen appreciably, advancing much of a rate cut’s impact. For example, 10-year Treasuries are down one percentage point since end-April and mortgage rates (for 30-year fixed) have plummeted. Oil prices are tanking, which will boost real incomes.
The Fed is clearly heading towards cutting the Fed Funds rate at its September gathering as Chair Jerome Powell foreshadowed at his last FOMC press conference. Further data may indeed buttress recession probabilities. But, for the time being, the reactions to the US July employment report and the emerging critique of the FOMC and its July decision are overdone. Markets should chill.
Mark Sobel is US Chair of OMFIF.
William Dudley will join Mark Sobel on Thursday 19 September to examine the outcome of the September FOMC meeting. Register to attend here.…Read more by Mark Sobel
