South China Morning Post
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People walk outside a Costco in Arlington, Virginia, on July 28. Headline consumer price inflation has hit a nearly 41 year-high at 9.1 per cent, even as two successive quarters of negative growth in the first half of the year mean the US economy has entered a technical recession. Photo: AFP
Opinion
Macroscope
by David Brown
Macroscope
by David Brown

US recession or not, the Federal Reserve is caught between a rock and a hard place

  • The US economy has entered a technical recession but the jobless rate is close to a 50-year low, a confusing state of affairs for both investors and policymakers
  • The US central bank must reaffirm its anti-inflation credentials and let the economy and jobs take the strain
David Brown
David Brown
Why you can trust SCMP
When is a US recession not a recession? Certainly not when the US economy is in the thick of a very dynamic jobs boom. After two successive quarters of negative growth in the first half of the year, the US economy has entered a technical recession. Meanwhile, the US labour market is racing away with the jobless rate close to a 50-year low and inflation alarm bells sounding.

We have entered the realm of bizarro economics, and it’s no surprise that investors are confused about whether the outlook means boom or bust for stock markets. It’s an even bigger dilemma for US policymakers whether to slam on the brakes or keep pressing the policy accelerator to the floor.

The Federal Reserve may be deeply conflicted, but the time has come to reaffirm its anti-inflation credentials and let the US economy and jobs take the strain – hopefully without too much collateral damage. A soft landing is looking more like mission impossible for the Fed.

The US economy may be showing the hallmarks of a downturn, but the National Bureau of Economic Research, the official arbiter of whether the United States is in recession or not, won’t declare it just yet. There’s the broader picture to consider, and the booming US labour market is a good reason to proceed with care.

July non-farm payroll data came in much stronger than anticipated last week, with US employers adding 528,000 jobs for the month, well above consensus forecasts for a gain of 250,000. It’s the drop in the unemployment rate to 3.5 per cent which has thrown a curveball to expectations that the economy is heading for a deeper decline, especially with average earnings rising by 0.5 per cent over the month, keeping year-on-year wage growth at a lofty 5.2 per cent.

But this bears the hallmarks of an extremely tight labour market, which could set off a more dangerous wage-inflation spiral, after 14 years of the Fed’s monetary super-stimulus following the 2008 crash and during the Covid-19 pandemic. For the Fed’s critics, there’s a palpable sense of the chickens coming home to roost, especially with US headline consumer price inflation hitting a nearly 41 year-high in June at 9.1 per cent. The odds are that there is worse to come.

Why it’s risky for markets to second-guess US, China central banks

Maybe the Fed ran too fast and loose with near-zero interest rates and excessive debt-monetisation for too long, but what was the alternative? Without the Fed’s unremitting monetary support for the economy since 2008, the US economy might have suffered a much worse fate, with mass unemployment and a financial market meltdown on a worse scale than the 1930s Great Depression. The Fed should be applauded, not scolded, for its past actions.

It’s clear the US is slowing down and economic markers are showing a recession is already here and likely to get worse in the coming months. The dip into negative territory has been shallow so far this year, with US growth slipping by 1.6 per cent in the first quarter and a further 0.9 per cent in the second quarter. Business confidence looks vulnerable, with the Institute for Supply Management’s manufacturing index slipping to 52.8 in July, the lowest reading since June 2020.

Economic headwinds are building and it is little surprise that the bellwether 10-year minus two-year US Treasury yield curve spread has shifted back into negative territory since early July, which is consistent with the economy in recession. It should be an opportunity for US policymakers to intervene and stop the rot spreading any further. The government could step up its fiscal stimulus with more assistance for US households, but this may not be the best tactic if it simply adds more fuel to the inflation fire in the short term.

The Fed is in a quandary as higher interest rates won’t dampen the cost-push inflation caused by the global energy crisis, which is beyond its control. The US central bank’s mission is to get the Fed funds rate back towards 3 to 4 per cent by 2024 and then check the lie of the land.

If it’s lucky, inflation should have peaked by then, growth and employment should have stabilised and interest rate normalisation should be secure, bar any further shocks. But it’s a high-risk strategy.

The Fed is walking a tightrope and for all our sakes needs to keep a steady head.

David Brown is the chief executive of New View Economics

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