The U.S. economy has yet to face its biggest recession challenge

A person removes the nozel from a pump at a gas station on July 29, 2022 in Arlington, Virginia.

Olivier Douliery | AFP | Getty Images

You would be hard-pressed now to find a recession in the rearview mirror. What’s on the road, however, is another story.

There is no historical precedent indicating that an economy in recession could produce 528,000 jobs in one month, as the United States did in July. An unemployment rate of 3.5%, tied for the lowest since 1969, is not compatible with the contraction.

But that doesn’t mean there isn’t a recession ahead and, ironically enough, it is the phenomenal resilience of the labor market that could pose the greatest long-term danger to the economy as a whole. The Federal Reserve is trying to ease pressure on a historically difficult employment situation and its rapid wage gains in an effort to control inflation at its peak. the highest level for more than 40 years.

“The point is, it gives the Fed extra headroom to continue tightening, even if it increases the likelihood of pushing the economy into recession,” said Jim Baird, chief investment officer at Plante Moran Financial Advisors. “It will not be an easy task to continue to tighten without negative repercussions for the consumer and the economy.”

Indeed, following the robust jobs numbers, which included a 5.2% YoY gain in the average hourly wage, traders accelerated their bets on a more aggressive Fed. As of Friday afternoon, markets were attributing around a 69% chance that the central bank will make its third consecutive interest rate hike of 0.75 percentage points at its next meeting in September, according to CME Group data.

So while President Joe Biden celebrated the big jobs count on Friday, a much nastier data point could be on the way next week. The Consumer Price Index, the most widely followed measure of inflation, comes out on Wednesday, and is expected to continue to show upward pressure even with a sharp drop in prices from gasoline in July.

This will add pressure to the Fed’s balancing act of using rate hikes to temper inflation without tipping the economy into recession. As Rick Rieder, chief investment officer of global fixed income at asset management giant BlackRock, put it, the challenge is “how to execute a ‘soft landing’ when the economy is booming and lands on a runway she has never used before.”

“Today’s much stronger-than-expected release complicates the job of a Federal Reserve as it seeks to create a more tempered employment environment, consistent with its attempts to moderate current levels of inflation,” he said. Rieder said in a client note. “The question now is how much longer (and higher) will rates have to last before inflation can be brought under control?”

More signs of recession

Financial markets were betting against the Fed in other ways.

The yield on 2-year Treasury bills exceeded that of 10-year bills by the highest margin in about 22 years on Friday afternoon. This phenomenon, known as the inverted yield curve, has been a telltale sign of a recession, especially when it lasts for a long time. In this case, the reversal has been in place since early July.

But that doesn’t mean a recession is imminent, only that it’s likely within the next two years. While that means the Fed has time, it could also mean the central bank won’t have the luxury of slow hikes, but instead will have to keep moving quickly — a situation policymakers hoped to avoid.

“It’s definitely not my base case, but I think we might start to hear some bullish talk between meetings, but only if the next batch of inflation reports are hot,” Liz Ann said. Sonders, chief investment strategist at Charles. Schwab.

Sonders called the current situation a “single cycle” in which demand reverts to services instead of goods and poses multiple challenges to the economy, making the debate more if the United States is in a recession less important than what awaits us.

It’s a view widely shared by economists, who fear that the hardest part of the journey is yet to come.

“While economic output contracted for two straight quarters in the first half of 2022, a strong labor market means that currently we are unlikely to be in a recession,” said Frank Steemers, senior economist at The Conference Board. “However, economic activity is expected to cool further towards the end of the year and it is increasingly likely that the US economy will enter a recession before the end of the year or the beginning of 2023.”

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