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Economists are sounding ever more like Gilda Radner of “Saturday Night Live” fame, claiming “never mind” about their recession call a few months ago. What’s behind their mea culpa? Well, the economy for one thing. The drumbeat of stronger-than-expected data continues to roll in, defying perceptions that activity is poised to collapse. Consumers are keeping their wallets wide open, as revealed in the robust retail spending report for July. Businesses are booking more orders for capital equipment and are building more factories. And the job market, while easing a bit, continues to generate far more openings than available workers.
Contrary to revised expectations – and robust economic data – the business cycle has not been repealed. Yes, Virginia, a recession is coming. But, like waiting for Godot, it is taking an awfully long time to arrive. When it does, its shape may look different, more like a mini recession than an outright downturn. This would be akin to a soft landing – a mild slide in output accompanied by few job losses. But if the weakness is pervasive and lasts more than a few months, it will nonetheless be labeled a recession by the National Bureau of Economic Research, the unofficial arbiter of when a business cycle starts and ends.
Amid a slim calendar of economic data, all eyes were on the Federal Reserve’s policy meeting this week, as well as what chair Jerome Powell had to say about the confab at the post-meeting press conference. The headline news that the Fed would not raise rates came as no surprise, as that was the bet by traders and commentators heading into the meeting. Any deviation would surely have upset the financial markets, something that the Fed usually tries to avoid. That said, the markets were hardly a model of tranquility following the meeting, as stock prices slumped, and yields surged throughout the maturity spectrum to levels not seen since before the financial crisis in 2007. While the Fed’s decision to hold rates steady confirmed expectations, so, too, did the unwelcome news that the Fed is inclined to hike another time this year and keep rates higher for longer next year as well. That hawkish bias was not entirely surprising, but the confirmation embedded in the Summary of Economic Projections by the 19 members of the policy committee still landed like a bombshell. Sometimes seeing the writing on the wall is more impactful than having confidence before learning what is likely to occur.
A raft of key economic data filled the calendar this week and, while some ran afoul of forecasts, the general narrative regarding the economy and monetary policy remained intact. If you're a gambling person, you would have hit the jackpot had you correctly predicted that both the consumer price index and retail sales rose 0.6 percent in August. The odds of a double six occurring with one roll of two dice is precisely 0.028 percent, a chance occurrence that is about as meaningless as the outsized headline reading for retail inflation and sales last month. Both increases exaggerate underlying trends, and neither will alter perceptions of policymakers or investors regarding the economic and inflation backdrop.
To the chagrin of the administration, recent polls reveal that the public has a dim view of the economy, with most households seeing it heading in the wrong direction despite generally upbeat data on jobs, income and, yes, inflation, which looms as the biggest concern among respondents. But the grim view held by the public is not as ubiquitous in business surveys, many of which report that things are just fine – and getting even better. The latest example is the survey of service providers by the Institute for Supply Management (ISM) whose index of activity shot up 1.8 points to 54.5 in August, the highest in six months and well above the consensus forecast. Most had expected a slight drop, consistent with the general view that the economy was cooling off.
Investors had a lot to process this week, highlighted by the widely anticipated remarks by Fed Chair Powell at the annual Jackson Hole Symposium. Unlike a year ago, when Powell shook up the markets with his warning that the Fed would inflict pain on the economy through higher interest rates aimed at taming raging inflation, there was nothing earth-shattering in his remarks this time. That's not to say the markets were calm, as stock prices swung widely during the week and yields continued to move higher. But late August is vacation time for traders when market moves tend to be amplified by noise more than substance. A better sense of market trends will have to wait until after Labor Day.
It was a rough week for investors, as stock prices tumbled for the third consecutive week and bond yields surged to the highest level in more than a decade, sending bond prices significantly lower. These sharp moves were influenced more by changing perceptions than actual events, although economic reports out this week continued to surprise on the upside. At the heart of things, traders and investors are becoming ever more convinced that the economy’s resilience is not a passing mirage but is poised to remain a feature of the landscape for the foreseeable future. That means the Fed will stay alert to the continued build-up of inflationary pressures, keeping future rate hikes squarely on the table. Indeed, the release of the minutes from the July 26 policy setting meeting confirmed that several Fed officials still believe another rate increase is warranted this year.
The latest consumer price report is adding fuel to the debate over whether higher unemployment is needed to tame inflation. For sure, the Federal Reserve has a major stake in the debate, as it must decide how forcefully it needs to restrain growth – and hence jobs – to bring inflation down to its two percent target. No doubt, policymakers are pleasantly surprised that progress on the inflation front has been so pronounced without sending workers to the unemployment lines. It enabled them to take a pause in their rate-hiking campaign in June, and it most likely will keep them on the sidelines at the upcoming September FOMC meeting. The financial markets are fully on board with that assessment, and then some, as the futures market is pricing in less than a 20 percent probability the Fed will raise rates in September and less than a 40 percent chance at the November policy meeting.