The Economy Is Not Rapidly Deteriorating

There is very little reason to believe that the U.S. economy is rapidly deteriorating. The U.S. economy is not in recession. And a recession in 2024 remains unlikely.

Market volatility was caused primarily by the Nikkei, and not by investor concerns about U.S. economic data. The Nikkei fell due to a surge in the yen. The narrowing gap between U.S. and Japanese rates makes the yen relatively more attractive. Bets that the yen would remain weak have started to look unattractive. The yen carry trade exploded.

An emergency inter-meeting cut by the Federal Reserve in response to market volatility and falling equity prices would be wildly irresponsible. It is not the Fed’s job to keep stock prices high. And such a move would only increase volatility by signaling that the Fed was panicking.

Concern about a recession is also driving U.S. market volatility. Might the sell-off push the economy into recession? It’s very unlikely. Of course, when equities drop, consumers have less wealth and consume less. This reduces aggregate demand, which increases the unemployment rate and creates slack in the economy. This slack can create a recessionary cycle. But magnitudes matter. A 10 percent sell-off in equities — and the associated changes in other asset classes — would be expected to reduce GDP growth by less than one percentage point over the subsequent year. Given expected GDP growth, this would not be enough to induce a recession.

Beyond equities, is the economy in recession?

No.

But what about the July jobs report, released last week? Rule No. 1 of analyzing economic conditions: Do not over-interpret one item of data. The three-month moving average of nonfarm payroll gains is 170,000. That is more than enough to sustain the expansion.

Yes, the unemployment rate went up from 4.1 percent in June to 4.3 percent in July. But the current level of the unemployment rate is not particularly troubling. More importantly, the unemployment rate went up for idiosyncratic factors. Hurricane Beryl disrupted the labor market. The unemployment-rate increase was driven by temporary, not permanent, layoffs. And the unemployment-rate increase was also driven by new entrants into the labor market.

The number of unemployed people increased by 352,000 in July. The number of unemployed people on temporary layoff increased by 249,000 in July. The number of unemployed people permanently laid off increased by 39,000. Temporary layoffs might reverse and historically are not a good recession predictor.

The labor force increased by 420,000 people in July. That is larger than the 352,000-person increase in the number of unemployed people, and much larger than the 67,000 net employment increase in July. It is quite plausible that the increase in the unemployment rate reflects in part temporary frictions from immigrants trying to find jobs.

Beyond the July jobs report . . .

1. Labor demand remains strong.
2. Layoffs have not increased, though hiring is trending down.
3. Income growth is solid.
4. Consumers are still spending.
5. Economic growth is projected to finish the year strong. For example, Goldman Sachs’s Q3 GDP tracking estimate is for 2.6 percent growth at an annual rate.
6. There has been no obvious shock to the economy that could abruptly change the outlook.

The challenge for the Fed is that things can turn on a dime: When the unemployment rate starts to rise a little, it goes on to rise a lot.

But that dynamic occurs when the initially small unemployment-rate increase is driven by softening economic demand. It does not occur when the initial unemployment-rate increase is due to a surge of immigrants who cannot immediately find jobs.

To the extent that immigration caused the increase in the unemployment rate, the Fed should not misinterpret it as a sign that the economy is rapidly deteriorating.

The bottom line is that there is little evidence that the labor market is rapidly deteriorating. Layoffs are trending down and are below their pre-pandemic level. Labor demand remains firm. Companies are responding to a gradually softening labor market by reducing hiring and job openings, not by laying off workers. The economy continues to add jobs at a solid pace. The fundamental drivers of labor demand are still present: Incomes are growing, and consumers are spending. Forecasters expect solid growth in the current quarter.

It strikes me as entirely plausible that labor-market and inflation data that are released between now and the September meeting suggest that the labor market is strong and inflation is not sustainably moving to the Fed’s target. In other words, the data very well could imply that the Fed should not cut at all in September.

That could be wrong. Inflation and/or the labor market could soften further, justifying a cut. But I see no reason for an emergency meeting, little reason to think a 50-basis-point cut will be called for, and little reason to conclude that the economy is rapidly deteriorating.