It’s difficult to find a recession in the past several years. But what lies beyond the next bend is a different matter.
There is no historical precedence that suggests a recessionary economy can create 528,000 jobs in a single month, as the United States did in July. A decline cannot be explained by a 3.5 percent unemployment rate, which is one of the lowest levels seen since 1969.
But that doesn’t imply there won’t be a recession in the future, and oddly, it’s the labour market’s extraordinary resilience that might represent the biggest long-term threat to the whole economy. In an effort to contain inflation, which is at its highest level in more than 40 years, the Federal Reserve is making an effort to reduce pressures on historically tight labour markets and rapid pay increases.
“The fact of the matter is this gives the Fed additional room to continue to tighten, even if it raises the probability of pushing the economy into recession,” Jim Baird, the organization’s chief investment officer, said. “It’s not going to be an easy task to continue to tighten without negative repercussions for the consumer and the economy.”
Indeed, traders increased their wagers on a more aggressive Fed after the strong job figures, which included a 5.2 percent 12-month increase for average hourly earnings. According to CME Group data, as of Friday afternoon, markets were giving the central bank’s decision to raise interest rates by 0.75 percentage points for the third consecutive meeting roughly a 69 percent likelihood.
Thus, while President Joe Biden praised the significant increase in employment on Friday, a much more unfavourable data point may be coming out the following week. The most popular inflation indicator, the consumer price index, will be released on Wednesday. It is anticipated to show ongoing increasing pressure despite a significant drop in fuel prices in July.
This will make it more difficult for the central bank to strike the right balance between containing inflation through rate hikes and avoiding a recession. The difficulty, according to Rick Rieder, chief investment officer of global fixed income at asset management behemoth BlackRock, is “how to execute a ‘soft landing’ when the economy is coming in hot, and is landing on a runway it has never used before.”
“Today’s print, coming in much stronger than anticipated, complicates the job of a Federal Reserve that seeks to engineer a more temperate employment environment, in keeping with its attempts to moderate current levels of inflation,” in a note to a client, Rieder said. “The question though now is how much longer (and higher) will rates have to go before inflation can be brought under control?”
Growing signs of a recession
In other respects, the financial markets were betting against the Fed.
Friday afternoon saw the largest difference in yields between the 2- and 10-year Treasury notes in approximately 22 years. An inverted yield curve is a phenomena that has historically served as a warning indicator of recession, especially when it persists for a protracted length of time. In this instance, the inversion has been present since the beginning of July.
However, it just means that a recession is likely to occur within the next year or two. While this gives the central bank some breathing room, it also raises the possibility that it won’t have the luxury of taking its time and instead would need to move swiftly, which is what policymakers had intended to avoid.
“This is certainly not my base case, but I think that we may start to hear some chatter of an inter-meeting hike, but only if the next batch of inflation reports is hot,” stated Liz Ann Sonders, Charles Schwab’s principal investment strategist.
The discussion about whether the United States is in a recession is less significant than what lies ahead, according to Sonders, who dubbed the current situation “a unique cycle” in which demand is shifting back to services from products and creating numerous problems to the economy.
Economists generally hold this opinion and believe the hardest part of the road is still to come.
“While economic output contracted for two consecutive quarters in the first half of 2022, a strong labor market means that currently we are likely not in recession,” Frank Steemers, a senior economist of The Conference Board, stated. “However, economic activity is expected to further cool towards the end of the year and it is increasingly likely that the U.S. economy will fall into recession before year end or in early 2023.”