Why “Must” We have A Recession? The Lady Doth Protest Too Much, Methinks…

Why are so many people howling for a recession?  To quote Bloomberg columnist John Authers…

Bringing inflation to heel is urgent. That could imply that the Fed has no choice but to execute the landing soon — as the alternative would involve zooming ahead and an eventual crash.

But that really the only choice?  A semi-controlled crash now or a [spooky music] “eventual crash” later on?  The lady doth protest too much, methinks…

After 18 months of drama, we have a pretty good handle on what’s behind the headline inflation numbers.

  1. Supply shock driven – post-COVID demand and the Ukraine war.  Note that energy prices have gone down a lot lately…
  2. Fiscal-policy driven. Fed-fetishizers really hate to admit how powerful those COVID checks proved to be.  As a Real Economy guy, I totally under-estimated them too.
  3. NOT particularly wage-driven – real wages are just not galloping ahead.  If you torture the data you can get to a more convenient conclusion, but…
  4. At least partly driven by “excess profit” – see the chart link before accusing me of playing politics.  “Excess” means “higher than it usual historical average” – an economics term not a moral or political judgement.  For more, see this paper by Isabella Weber and other economists chiming in on her twitter feed.  She got written up in the New Yorker, but goes oddly unmentioned in the WSJ or FT 🙂

So where are we today?  Does this really solve for “we must engineer a recession as soon as possible!!!!”?  Maybe it solves better for “take a step back and let the free market sort itself out?

  1. Supply shocks are gone (NY Fed).
  2. Fiscal policy effects are fading.
  3. Real wage growth isn’t ringing alarm bells – at least not in the US.  Wages have gone up a lot for the bottom quartile, but top quartile has seen reduced purchasing power (Atlanta Fed).
  4. Profit margins are still high, but that’s not something Fed policy can change directly.  Either you believe the free market will eventually do its work, or the FTC and DoJ are the relevant agencies…
  5. Inflation expectations are heading down and look super duper well anchored (Cleveland Fed). 
  6. Alternate, pretty clearly more accurate measures of inflation are well out of the Red Zone.  The NY Fed is not a left-wing think tank and 3.5% is not a crisis.
  7. Real (Inflation Adjusted) interest rates are positive after a rapid +500bp adjustment.

Could there be another agenda behind all the brave talk of belt-tightening and necessary sacrifice?  Maybe people don’t want to re-price existing assets for a world with rates running in the 3%-5% range.  Today, they are sitting on paper losses.  If this all goes on too long, however, time will convert those into real losses.

To avoid those losses, those people need rates to return (quickly) to the low levels we had pre-COVID in the 2010’s.  The post-GFC era of soggy, deflationary growth.  If it takes a crushing recession to bring those low rates back, that is (for them) the lesser of two evils.  Sluggish growth will cost them less than the mark-to-market losses.

The above may sound “political,” but “politics” is what happens when a social group pursues its own self-interest.  The politics lie in pretending otherwise – hiding a political agenda behind a smokescreen of (remarkably unsupported – really!) econo-babble.  If there is anything “political” here, it is in that deception.

What we do know is this:  Pretty soon the headline inflation numbers and the political calendar are going to make it awkward to press too hard or too loud for a recession.   Per the NY Fed’s clearly-more-realistic-for-the-present-moment data series, 3.5% is not a crisisPerhaps that time growing short better explains the urgency some people feel for a bum rush into a recession…?

Note that, last year, I also expected a return to ” slow, deflationary growth.”  I didn’t expect a mega-recession, but I also didn’t expect the Real Economy to be this resilient. Partly because I figured the “get back to low rates” political agenda would prevail.  The real economy thought otherwise…

When the facts change, you should try to change your mind.  So now I’m considering other scenarios.

Right now, however, I have no strong views and they are even more lightly held than usual…

This just in:  I’m going to paste in a verbatim quote from the Indeed job site’s analysis of today’s jobs data.  Is 3.5% inflation maybe not so bad if it also gets us this?  And who thinks otherwise?

The US labor market wrapped up the first half of 2023 in a position of strength, and it will take something dramatic happening to derail it anytime soon.

Don’t dismiss job growth of 209,000 per month. Yes, this pace is notably slower than what we’ve seen in recent years. However, given the slowing growth of the US population, we’d need job gains of somewhere between 60,000 and 80,000 per month to keep up with labor force growth. So gains in excess of 200,000 are more than double the pace needed to keep the labor market tight.

The results of this continued strong hiring can be seen in the growth of the prime-age labor force. The share of workers ages 25 to 54 in the labor force rose again to 83.5%, the highest rate since May 2002. Women saw another strong rise over the month, continuing their more rapid post-pandemic bounceback. The participation rate for prime-age women is not only above its 2019 level, but it also set an all-time high for the third straight month.

The sources of the job gains have some surprises in both positive and negative directions. Construction continues to be notably resilient, adding 23,000 jobs in June, with almost half of those gains coming from residential specialty trade contractors. On the flip side, accommodation and food services job gains, a constant source of jobs in the post-pandemic recovery, dropped dramatically to under 5,000 a month, a steep decline from the roughly 60,000 a month on average it added in the year prior.

The labor market is slowing down, but it’s doing so from a position of strength. This report is just another proof point that the labor market is going through a welcome moderation. Demand for workers is high but slowing, and the supply of workers is growing. Nothing is guaranteed, but the US labor market continues to point toward a slower, but more sustainable pace of economic growth.

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