Whatever Happened to the Impending Recession?
What if they scheduled a recession and no one showed up? We still see no recession in sight, as the latest jobs report showed blow out gains. We do not dismiss the possibility that a recession may be required to bring inflation back to the Fed’s 2% target. But it isn’t imminent. The Fed has signaled that policy will pause (or skip) in May and be re-evaluated based on incoming data for the next meeting. So, the waiting game continues.
With the artificially created “debt ceiling crisis” over, market attention has reverted to the health of the economy based on widespread expectations that growth is slowing and a recession might be imminent that would force the Fed to pivot. Such wishful (?) thinking was blown away by the data, yet again. Yes, growth has slowed, although not enough. Yes, inflation has moderated, but also not enough. This remains a recurring pattern. After a nonstop string of rate hikes that brought the cost of overnight money to as much as 5.25%, many investors conclude (or assume) that a downturn is inevitable. That view was reinforced by the collapse of three banks in March and the subsequent tightening of lending terms that followed. Now, it is thought that reduced spending from the budget deal will hamper growth, as will as much as $1 trillion in new debt issuance by the U.S. Treasury to rebuild its cash balances. Much of this seems to be a forecast (of recession) in search of evidence to reinforce that predetermined outcome. The data simply does not line up in support.
The latest jobs report is an excellent example of this behavior. While the more consistently reliable payroll data showed a 339,000 rise in net hires in May and positive revisions to prior months of 93,000, it was taken as a mixed report, because the notoriously more volatile household survey showed a rise in unemployment of 440,000 and a rise in the unemployment rate to 3.7%. Other data, including ADP employment and weekly initial unemployment claims, suggest that the labor market remains quite solid and those who lose their jobs find work elsewhere fairly quickly. We have been expecting slower job growth, mostly because hiring should become ever more difficult as the number of unemployed declines, so fewer people are available to be hired. That has played out more slowly than expected, as overall labor force participation has rebounded, even as those 55 and older have not returned to the workforce. Nonetheless, the trend is not our friend in this regard.
Mortgage rates have increased, but housing demand appears to have bottomed after a difficult 2022 and is now recovering. Because so many people locked in low mortgage rates over the past few years, they are now disinclined to move and resales of existing homes remain quite low, much to the chagrin of realtors. But if you can’t buy an existing home, buying new construction is an option. Construction worker hiring has improved and their wage rates are rising by more than 5%. Home builders report recovering demand. Spending on infrastructure and green initiatives also help.
Reduced willingness of banks to lend will surely hurt, but only at the margin. The last time I looked, banks were in the business of lending. They won’t make money if they don’t lend. Qualified borrowers will always find lenders. Treasury bond issuance will also drain some liquidity from the banking system, but the Treasury bill market is extremely large and very liquid. Don’t expect short-term interest rates to increase from all the issuance, if the Fed chooses to pause monetary policy.
But why might the Fed pause, if growth is still a bit too strong and inflation isn’t coming down as quickly as hoped? There is some merit, not much but some, in the idea that the full impact of the rate hikes is yet to be seen. And the Fed does not wish to be seen as deliberately promoting a recession to curb inflation. That may be needed down the road, but that is most certainly not their first preferred approach to bringing down inflation. In the meantime, the market’s hope that the Fed will soon pivot and reduce rates seems unrealistic. While the Fed will very likely follow through on their public statements that a pause may be appropriate for the moment, they are surely nervous that the economy is holding up well and further moderation in inflation may be more difficult to achieve. With no signs of recession and rate hikes on hold (and the debt ceiling crisis behind us), we just might be able to look forward to a quieter summer.
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