Economy Commentary
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“Nowhere Near Almost Done”

August 2022

The (not so) great debate over whether or not the U.S. economy is in recession rages on. No matter what media platform you choose to engage, it’s hard to avoid what has seemingly turned into a nonstop shouting match. Indeed, our normally sedate knitting group nearly came to blows over this after the release of the July employment report. Though, if we’re being honest, it was probably wrong for a certain member of the “no, it isn’t” camp to throw a copy of the July employment report at a member of the “yes, it is” camp as a means of proving their point. In any event, we see that debate as being totally irrelevant and would prefer to put that tossing of the employment report incident behind us and let the data settle it. Anyone wanting to insist that the economy is in recession is free to do so, even if there is nothing in the economic data to support that contention. At the same time, however, just because the economy isn’t there yet doesn’t mean it won’t be later this year or in 2023.

Those insisting the economy is in recession base their contention on real GDP having contracted in each of the first two quarters of 2022. The initial estimate from the Bureau of Economic Analysis (BEA) shows real GDP contracted at an annual rate of 0.9 percent in Q2. That contraction, however, is more than fully accounted for by a smaller build in nonfarm business inventories in Q2 than was the case in Q1, which deducted two percentage points off the quarterly change in real GDP. Hardly the stuff of which recessions are made.

July job growth blew expectations out of the water, with nonfarm payrolls rising by 528,000 jobs, more than double the consensus forecast, while prior estimates of job growth in May and June were revised higher. Between these upward revisions and July’s gains, the level of nonfarm employment has finally surpassed its pre-pandemic peak. The unemployment rate fell to 3.5 percent in July, though this in part reflected a decline in labor force participation. The July employment report also showed a larger than expected increase in average hourly earnings, which was in line with the Q2 data on the Employment Cost Index (ECI), a measure of total labor compensation costs (wages and benefits) that many, including the FOMC, see as the most reliable gauge of trends in labor costs. The Q2 ECI data show private sector wage costs rose 5.7 percent year-on-year, the largest such increase in the life of the current series, while benefit costs posted their largest year-on-year increase since 2005.

As of June, the latest available data, there were 10.698 million open jobs across the U.S. economy. While this marks the third straight monthly decline, the number of job vacancies nonetheless remains over fifty percent higher than pre-pandemic levels. Moreover, over two-thirds of June’s decline was accounted for by construction and retail trade, areas of the economy which have clearly slowed over the past several weeks. At the same time, the rate at which firms are hiring workers and the rate at which workers are voluntarily quitting jobs remain far above their pre-pandemic norms. All of which affirms a point we’ve been making for some time now, which is that labor supply remains no match for labor demand and, as such, there is little reason to expect meaningful easing of wage pressures until the labor market is brought into better balance.

The Institute for Supply Management’s (ISM) July surveys of the manufacturing and services sectors show continued expansion in the two broad sectors, with the services sector survey coming in much stronger than had been anticipated, including an acceleration in the growth of new orders. Two elements of the July ISM surveys worth noting are signs of relief from supply chain constraints and signs that non-labor input price pressures are easing. To be sure, supply chains are far from operating freely and normally but, even so, signs of progress in that direction are most welcome. And, while input prices are still rising, they are doing so at a slower pace, which is consistent with recent declines in energy and commodity prices.

While falling retail gasoline prices will take some of the steam out of the month-to-month changes in the Consumer Price Index (CPI) and the PCE Deflator, they will bring little relief in terms of the over-the-year changes. For instance, it is anticipated that, after having risen by 1.3 percent in June, the CPI rose by just 0.3 percent in July, but that would nonetheless leave the over-the-year change at 8.8 percent. Moreover, the July data are expected to show core CPI inflation accelerating from June’s pace, and we expect that acceleration to persist into the fall.

Where does this leave the FOMC in their quest to “do a job on demand” as a means of reining in inflation? If anything, the FOMC’s task now seems even more daunting than it did when the Committee embarked on its course of rate hikes in March of this year. Thus far, the labor market seems to have not even noticed the FOMC’s attempts to push down labor demand as a means of alleviating wage pressures. At the same time, the inflation data have yet to bring anything close to the “clear and convincing” evidence of slowing inflation that the FOMC has stated they need to see before thinking of backing off the current course of Fed funds rate hikes.

Even before the release of the July employment report, San Francisco Fed President Mary Daly noted that the FOMC’s work was “nowhere near almost done,” and it could be that still-strong labor market data emboldens the FOMC to be more aggressive than would otherwise have been the case. After having, somewhat curiously we might add, come to the conclusion that the FOMC had, at its July meeting, undertaken a “dovish pivot,” market participants have abandoned this interpretation, and market pricing implies a better than even chance of another 75-basis point Fed funds rate hike at the September FOMC meeting. Whether, or to what extent the FOMC moves at a slower pace after September will depend on the incoming economic data. In short, the higher and more persistent inflation proves to be, the further the FOMC will go, and the further the FOMC goes, the greater the probability that they push the economy into recession. As such, it could be that those insisting that the U.S. economy is in recession weren’t wrong but instead were just early.

Source: Federal Reserve Board; Bureau of Economic Analysis;Bureau of Labor Statistics; Institute for Supply Management

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