No matter which media platform you choose to engage in, the economy is almost always the headline news story. Arguments over whether or not the economy is in recession and the influx of seemingly conflicting data creates uncertainty and even fear. But here’s what you need to know about the current economic conditions right now.
1. It’s confusing, even for those of us who do this for a living.
The pandemic and the policy response to it have had profound effects on the economy, both at home and abroad. Many previously reliable patterns in economic activity have been significantly disrupted.
The economic data are sending mixed messages at a time when central banks around the globe are acting aggressively, though somewhat belatedly, in response to the highest rates of inflation in over four decades. This makes it challenging to assess how the economy is performing today, let alone to predict where it may be tomorrow. After all, it’s hard to know where you’re going if you’re not sure where you are.
2. The economy is not now in recession, but a recession can’t be ruled out.
It’s become almost impossible to avoid the media debate over whether or not the economy is in recession. Indeed, Google searches for “recession” are far more common now than ahead of the 2007-09 recession, or “the Great Recession.”
Real Gross Domestic Product, or GDP, contracted in each of the first two quarters of 2022, and while two straight quarterly declines in real GDP is a commonly used definition of recession, that is not the definition used by the National Bureau of Economic Research (NBER), the unofficial arbiter of turns in the business cycle.
The NBER defines recession as “a significant decline in economic activity that is spread across the economy and lasts more than a few months” and uses a host of economic variables to help them make their calls on turns in the business cycle.
The two variables the NBER deems as the most important are nonfarm employment and real personal income excluding transfer payments. Right now, none of the variables the NBER relies on are indicating recession, particularly these two. That does not mean we won’t ever get to that point, particularly given the effects of the Federal Open Market committee (FOMC) aggressively raising interest rates to combat elevated inflation.
3. Elevated inflation is being felt throughout the economy.
Businesses are paying significantly higher costs for labor and other inputs to production and have been fairly aggressive in passing along these higher costs to their customers in the form of higher output prices.
Much of the inflation we are now facing stems back to global manufacturing and shipping hubs having been shuttered in the early phases of the pandemic and the significant degree of financial support provided to U.S. households in response to the pandemic.
What was already elevated inflation was exacerbated by Russia’s invasion of Ukraine, which led to further spikes in food and energy prices. With prices for necessities such as food, energy, and shelter, rising at rapid rates, many households are having to curb discretionary spending, and some are taking on more credit card debt to help sustain their spending.
To the extent that their income just can’t keep pace with rising prices and/or they become concerned that a recession may impact their job and income, consumers will begin to cut back on spending.
4. After falling behind the (inflation) curve, central banks are pushing hard to catch up.
Central banks around the globe, including the Federal Reserve, responded to the pandemic by providing a high degree of monetary accommodation, but continued to so well after inflation had begun to accelerate.
It is important to central banks that high inflation not become entrenched in business and consumer expectations, as this would impact their decisions and weigh on the pace of economic growth. What is making their job much harder, however, is that many of the inflation pressures now confronting them originated on the supply side of the economy, which central banks cannot directly impact with their policy tools.
Since they can’t make the supply side of the economy better, the only way central banks can impact inflation is to, as Fed Chairman Jerome Powell put it, “do a job on demand.” Higher interest rates will curb spending in interest sensitive areas of the economy, such as housing and consumer durable goods, and to the extent higher rates lead to decline in equity prices, “wealth effects” will weigh on overall discretionary spending. As demand slows, firms will curb production which in turn will lead them to demand less labor.
Unfortunately, this is a blunt, imprecise, and indirect approach, raising the risk of a policy mistake leading to a more pronounced slowdown than anticipated. The higher and more persistent inflation proves to be, the more aggressive central banks have to be, raising the risks that it all ends with a recession.
5. Risks to the economy will be more pronounced later this year and into 2023.
July job growth blew expectations out of the water, with nonfarm payrolls rising by 528,000 jobs, more than double expectations, while the unemployment rate fell to 3.5 percent.
At the same time, consumer spending on services, such as travel, tourism, dining out, recreation, and entertainment, has been notably strong during the summer. Many consumers are setting concerns over the economy aside and not letting higher prices deter them from experiences they may have been putting off for over two years.
That said, July’s pace of job growth is clearly not sustainable, and we think that services spending will slow sharply with the end of summer. It is also important to recall that the effects of higher interest rates work their way through the economy fairly slowly, meaning the effects of higher interest rates could begin biting harder as the economy is already slowing.
Given that the Fed is, in the words of San Francisco Fed President Mary Daly, “nowhere near almost done” in their quest to rein in inflation, we and many other analysts see a greater chance that recession could come toward year-end 2022 and into 2023. While not inevitable, a recession may be hard to avoid without meaningful relief from global supply chain and shipping bottlenecks.
These unpredictable conditions change quickly, and we will continue to monitor the data to help our bankers and customers navigate the current environment.