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In real estate, they say that location is everything. In economics, timing is paramount. With prices rising at a pace not seen since the early 1980s, the Federal Reserve admittedly waited too long start putting on the brakes, believing that the initial stage of the inflationary upsurge last year was transitory and would fade once pandemic-related supply disruptions cleared up. Unfortunately, the Fed also underestimated the strength of demand that was colliding with supply shortages, an imbalance that continues to this day.
Last year, the main debate among economists was whether the inflation upsurge that suddenly gripped the nation was transitory or lasting. Most, including policymakers at the Federal Reserve, blamed transient forces related to the pandemic, which they believed would fade as health conditions improved. That view, of course, has since been debunked, and the Fed openly admits it waited too long to start the anti-inflation campaign that is now in full swing. At its last policy meeting on June 16, the Fed hiked short-term rates by three-quarters of a percentage point, the steepest one-off increase at a meeting since 1994, and signaled that several more increases were on the way in coming months.
After suffering through a yearlong battering of unrelenting bad news, inflation doves finally had a week to celebrate. For sure, it's still unclear if we are seeing the beginning of the end of accelerating inflation, or the beginning of false positive readings that obscure the true inflation trend. That unanswered question looms large and the fog of uncertainty won't clear up for at least several more months. Nor does it move the needle on the policy front, which remains steadfast in the inflation fight and instills concerns about a mishap. That said, baby steps should be rewarded, and the financial markets are eagerly embracing the positive signals that shone brightly over the past week.
If the U.S. economy is in a recession, the HR departments of Corporate America didn’t get the memo. Employers added a blockbuster 528,000 workers to payrolls in July, more than double expectations, while revisions to May and June added 28,000 to the already heady increases for those months. So far this year, job growth averaged 471,000 a month, while the unemployment rate fell to 3.5 percent, matching the lowest level in more than 50 years. During the final seven months prior to the brutal – but brief – 2020 recession, job growth averaged 221,000 a month. Following the July increase, all of the pandemic recession job losses – more than 20 million – have been recovered, a feat accomplished in a remarkably short time, given the deep hole the labor market had to climb out of.
If it looks like a duck and swims like a duck…is it a recession? It might take months, or even years, for the National Bureau of Economic Research (NBER) to settle a question that is currently the central focus of debate among economists and pundits. From our lens, the economy is still swimming above water, but the tide appears to be running out and the Fed is making waves that could sink the boat. Despite the uncertainty over whether the economy will swim or sink, the financial markets are behaving like drunken sailors. The S&P 500 posted its biggest percentage gain for a month in July since November 2020, erasing about a third of the 24 percent plunge wrought by the bear market during the first half of the year. Bond investors also switched gears, replacing earlier fears that the Fed fell too far behind the inflation curve to the belief it has caught up and is poised to shift into reverse sooner rather than later. That pivot in thinking brought the 10-year Treasury yield down to under 2.70 percent this week, from an 11-year high of 3.50 percent in mid-June. It also brought about a steeper inversion of the yield curve that is a time-honored leading recession indicator.
The heat wave engulfing broad swaths of the nation – and even more so overseas – is in stark contrast to the distinct chill that infiltrated the economic data over the past week. If nothing else, the downbeat signals portrayed by the latest housing data and a softer labor market amplify erratic perceptions in financial markets regarding recession prospects. A week ago, investors were cheered by a stronger-than-expected retail sales report suggesting a still vibrant consumer that would keep the economy on a growth trajectory. The strength in consumer spending followed the eye-opening report of a 9.1 percent inflation rate that fueled expectations the Fed would hike rates by an aggressive one percent at its upcoming policy meeting next week instead of a more modest three-quarters of a percentage point.
Fears of an imminent recession took a step back this week even as inflation alarms rang louder, prompting ramped-up expectations of a more aggressive response by the Federal Reserve. The latest data on consumer spending – the economy’s main growth driver – highlights the importance of watching what households do, not how they feel. For sure, Americans are in a downbeat mood, with an outsized fraction believing the economy is heading in the wrong direction and sentiment overall sitting near record lows, according to the University of Michigan’s latest polling. If actions aligned with feelings, consumers would have zipped up their wallets and sent the economy into a tailspin by now.
It wasn’t exactly a Goldilocks report, but the latest jobs numbers were comforting enough to keep the bears at bay. For sure, fears that the economy is running too cold and on the precipice of a recession – if not already in one – received little support from the sturdy increase in nonfarm payrolls last month. The 372,000 gain in June significantly exceeded the more Goldilocks-like consensus estimate of a 250,000 increase. The latest advance in job growth follows hefty increases of 384,000 in May and 364,000 in April, although the latter was revised down by a sizeable 68,000 from the previous estimate. Still, a job gain of close to 400,000 is hardly consistent with an economy that is on the cusp of a downturn.
Following the winter doldrums the normally hopeful spring brought nothing but the blues for investors and policy makers in the just concluded second quarter. The stock market turned in another dismal performance, resulting in the worst first-half for the S&P 500 since 1970. Fixed income investors fared little better; their losses were shallower than the stock market, but their negative returns were still the deepest in modern history for the first half of the year. Simply put, except for commodities and cash there’s been virtually no place to hide so far in 2022. And given the loss of purchasing power over the period, holding cash was not a rewarding option.