Unexpectedly weak U.S. jobs data indicating high unemployment post-pandemic has reignited recession fears, undermining the Federal Reserve’s hopes for a soft landing for the economy.
Stock markets are reeling as investors believe the Fed has kept interest rates high for too long.
So, how is the U.S. economy doing right now? One data point rarely tells the whole story. However, if you look at a range of indicators, some support continued growth and the absence of a recession, while others do not.
Most recessions begin with a noticeable drop in overall economic output, also known as gross domestic product. That hasn’t happened yet and probably won’t happen anytime soon.
Second-quarter growth was 2.8% year-over-year, double the pace of the first quarter and in line with the average of the past six quarters, as well as the average growth rate in the three years before the pandemic.
While the growth structure is changing, one measure that the Chair of the Federal Reserve Jerome Powell tracks as an indicator for underlying private-sector demand—final sales to private domestic buyers—remained steady at 2.6% in the second quarter. This is in line with the average for the past 18 months and before the pandemic.
The Institute for Supply Management’s Index of Activity in the Services Sector has returned to growth, with new orders and employment showing improvement. A competing index from S&P Global was near its highest point in two years in July.
Interest rates are high as inflation rose sharply in 2021 and 2022, and has been slowing down more gradually than it increased. The year started with an unexpected rise in inflation, putting pressure on the Fed to cut rates.
That being said, new data indicate that inflation is approaching the Fed’s 2% target, which should soon allow it to start cutting rates. Many investors are now wondering: Has the Fed waited too long to shift its focus from inflation to employment?
U.S. employers have reduced their hiring efforts, adding an average of about 170,000 jobs each month over the past three months, and only 114,000 in July. This is a stark contrast to the 267,000 jobs added per month in the first quarter of 2024 and 251,000 last year.
The unemployment rate increased to 4.3% in July, nearly a percentage point above the January 2023 low and the highest since October 2021. Historically, when unemployment starts to rise like this, it doesn’t stabilize until the Fed cuts interest rates.
According to Sahm Rule, a recession starts when the three-month moving average of the unemployment rate rises half a percentage point above the low of the previous 12 months. This rule has never been wrong. Claudia Sahm, the economist who created the rule, told Bloomberg TV that she believes the economy is probably not in recession yet, but “we’re getting uncomfortably close to that situation.”
Recent economic reports have frequently failed to meet expectations, with Friday's weak employment data being the latest example. The Citigroup Economic Surprise Index is near a two-year low, suggesting that investor confidence in the Fed’s ability to achieve a soft landing for the economy is diminishing.
The 2020 recession led to extensive fiscal and monetary interventions, with the Fed reducing interest rates to zero and purchasing trillions in bonds, while Congress and presidential administrations spent trillions to support the economy.
This time, the situation might be different, as the Fed’s current policy rate of 5.25% to 5.5% offers more room to lower borrowing costs. However, the high levels of U.S. government debt could restrict the potential for fiscal stimulus.
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