Recession versus reality: US contraction fears collide with activity data

The US economy has not yet received the memorandum warning that it should already be in recession. The brutal GDP report released on July 28, showing that the US economy had contracted for the second straight quarter, led analysts to insist that the dreaded recession had already arrived.

And in a way, that makes sense: since 1948, every period of consecutive quarters of negative growth has coincided with a recession.

But the argument that the recession is already here has been severely undermined since the GDP report was published. A series of events over the past 10 days suggest that these signs of recession are, to say the least, premature.

Yes, the economy is cooling off after last year’s growth. But no, it doesn’t seem to be experiencing the kind of slump that would qualify as a recession.

Consider the following developments:

• The economy created more than half a million jobs in July alone.
• The unemployment rate dropped to 3.5%, tied for the lowest level since 1969.
• Inflation cooled (relatively speaking) in July for both consumers and producers.
• Gasoline prices fell below $4 a gallon for the first time since March.
• Consumer sentiment rose after hitting record lows.
• The stock market recorded its longest weekly winning streak since November.

Mark Zandi, chief economist at Moody’s Analytics, said he has become more confident that the US economic recovery is intact.

“This is not a recession. It’s not even in the same universe as a recession,” Zandi told CNN. “It is just plain wrong to say that it is [recessão]”.

Zandi said the only thing that signals an ongoing recession is consecutive quarters of negative GDP. However, he predicted that these GDP declines will eventually be revised. And there are initial indicators that GDP will be positive this quarter.

Of course, none of this means the economy is healthy. Is not. Inflation remains very high. And none of that means the economy is out of the woods. She is not here.

A recession remains a real risk, especially in the coming year and 2024, as the economy absorbs the full brunt of the monstrous interest rate hikes by the Federal Reserve (Fed), the American central bank system.

And it’s still possible that the economy will stumble so much in the coming months that economists at the National Bureau of Economic Research, the official arbiter of recessions, will end up declaring that a recession started in early 2022. But for now, it’s too early to say that that’s the case.

The job market is still hot

The biggest problem with arguing that a recession has already started is the fact that hiring increased – dramatically – in July. The United States added a staggering 528,000 jobs last month, returning payrolls to pre-Covid levels.

An economy in recession does not create half a million jobs in a single month.

“I don’t think anything in the data about where we are now in the economy is consistent with what we normally consider a recession,” Brian Deese, director of the National Economic Council at the White House, told CNN in a phone interview last week.

If there is anything, it is the job market that is very heated. And that’s a problem for the next few months because it allows the Federal Reserve to aggressively raise interest rates without resulting in widespread damage to the labor market in its attempt to slow the economy.

The risk is that the Fed will end up slamming the brakes so hard that it slows the economy into recession.

Inflation is cooling down at last

There is a growing sense that perhaps the worst is over with regard to inflation.

The biggest headache of inflation – gasoline prices – is finally slowing down a lot. The national average for regular gasoline has dropped more than $1 since hitting a record $5.02 a gallon in mid-June.

In addition to gasoline, diesel and jet fuel prices are also falling, easing inflationary pressure on the rest of the economy.

The energy slowdown lowered inflation metrics in July and is expected to do the same, if not more, in August.

The Bureau of Labor Statistics said last week that consumer prices were 8.5% higher in July than a year earlier. While this remains alarmingly high, it is down from the 40-year high of 9.1% in June. And, month by month, prices have changed little.

Wholesale inflation may also be peaking. The producer price index, which measures the prices paid to producers for their goods and services, decelerated in July more than expected from a year earlier. And the index fell month-on-month for the first time since the economy closed in April 2020.

The higher-than-expected inflation reports reflect not only lower energy prices, but also the relief of stress on supply chains hampered by Covid-19.

What would a recession look like?

In a way, the recession debate is semantic.

Recession or not, Americans are clearly suffering right now because the cost of living is so high. Real wages, adjusted for inflation, are shrinking. And while consumer sentiment, as measured by the University of Michigan, has risen two straight months, it remains near record lows.

However, for many, an actual recession would be far more painful than the current environment.

A recession would likely involve the loss of not just hundreds of thousands, but millions of jobs. Unable to pay their mortgages, families would face moving out of their homes. And small, medium and large companies would go bankrupt.

None of these things are happening in any significant way, at least not yet. But flashing red lights on the bond market suggest that could change.

The yield curve—specifically, the difference between 2-year and 10-year Treasury yields—remains inverted. And in the past, that was a frighteningly accurate predictor of recessions. This has preceded every recession since 1955.

All in all, recent economic data suggests that the potential recession may have been delayed, not canceled outright.

While the risk of a recession in the next six to nine months appears to have decreased, Zandi said, the risk in the next 12 to 18 months has increased.

“The chances of a recession are still uncomfortably high,” he said.