What to make of America’s topsy-turvy economy
Summary
- Don’t panic just yet
Don’t blame American investors for feeling seasick. The past few weeks have brought a swirl of contradictory economic news: stock prices sank and then rebounded; jobs figures were weaker than predicted but retail sales were much stronger. Chatter about an immediate emergency interest-rate cut by the Federal Reserve built up and then died down. After the exuberance of the first half of 2024, economy-watchers are anxiously poring over each new data release. The utterances of Jerome Powell, the Fed’s chairman, at the Jackson Hole gathering of central bankers on August 23rd, after we published this, will be examined even more closely than usual.
What is going on? Economic data can often be volatile around turning-points, and several oddities are obscuring the picture. Take a step back, though, and America’s economy seems poised for a gradual slowdown, not a crash.
The most marked area of weakness so far has been the labour market. Unemployment jumped to 4.3% in July, a big enough leap to invoke the Sahm Rule, an indicator based on the rise in joblessness that has identified every American recession since 1960 (but which has a patchier record in other countries). Another rule, which uses both unemployment and job-vacancy figures, implies that a recession might have begun as early as March. Markets nervously await the next jobs release on September 6th.
Dig into the data, though, and it looks as if this weakness may be overstated. Much of the rise in unemployment in the latest figures came from temporary lay-offs, which tend to be volatile. America’s recent surge in immigration might also be influencing the data; new migrants are often not in work until a little after their initial arrival. Some of the rise in unemployment, therefore, may be short-term.
History may also be muddling things. Investors may be so jittery because they have over-learned the lessons of the previous two big recessions: during the global financial crisis of 2007-09 and the covid crash. Both of those were faster and deeper than a typical downswing, amplified as they were by a fragile banking system and a pandemic, respectively. They may not be the best guide to what to expect today.
Conventional slowdowns are often stop-start and gradual. A better guide than 2008 or 2020 may be the more subdued environment of the 1990s and early 2000s. Another more recent precedent might be mid-2019, when the Fed smoothed over a growth hiccup by unwinding some previous interest-rate rises.
How, then, to describe the current state of the economy? It is certainly slowing, and likely to slow further. A peculiar feature of this cycle has been that tight monetary policy and loose fiscal policy have pulled in opposite directions. Thus far, the tug-of-war has left the economy expanding at a rapid clip; GDP growth was 3.1% over the past year. But a pace that speedy cannot be sustained for ever: most estimates put America’s long-run potential growth rate at closer to 1.5-2% a year.
A good measure of the overall thrust of the latest economic data is the Atlanta Fed’s “nowcast" of GDP growth, which draws on a wide swathe of data. That has fallen over the past two weeks—but to a still healthy 2%. Conditions could yet deteriorate further if the lagged effect of high interest rates starts to bite. Some households are already feeling a squeeze: the share of credit-card bills left unpaid has risen to a 13-year high.
It should help, though, that the economy is far better situated today than in 2019 in one crucial respect: there is plenty of room for the Fed to ease. Investors expect interest rates to fall from their current range of 5.25-5.50% by more than two percentage points in the next year. Those cuts are already reflected in lower long-term bond yields. But interest rates could comfortably fall further and faster if worse news on the economy demanded it. By contrast, a fall of two percentage points in 2019 would have returned rates all the way to zero.
How much of the fuel left in the Fed’s tank will be needed? At Jackson Hole last year, Mr Powell signalled his determination to raise rates until inflation was back at its 2% target. Today inflation is nearly back to where it needs to be and the growth outlook is shakier. An interest-rate cut of a quarter of a percentage point in September seems almost certain.
Powell, so confusing
But central bankers should beware of overreacting. Financial markets are still pricing in a one-in-three chance of a jumbo rate cut of half a percentage point. Unless further bad news arrives, such a sharp move could go too far. The Fed faces danger from two sides: if it cuts too much, it could risk another surge in inflation; if it cuts too little, growth could falter more. Mr Powell has made admirable progress fighting inflation so far. His reward is that he now faces a new enemy, even as the old one is not yet fully defeated.
© 2024, The Economist Newspaper Ltd. All rights reserved.
From The Economist, published under licence. The original content can be found on www.economist.com
