Market Analysis

An unexpectedly weak U.S. employment report, showing a post-pandemic high in the jobless rate, has reignited concerns about a potential recession, threatening the Federal Reserve's goal of achieving a soft landing for the economy.

With stock markets shaken by the notion that the Fed has kept interest rates too high for too long, the previously dominant narrative of a "Goldilocks" economy has been replaced by bearish sentiment.

What is the current state of the U.S. economy? While no single data point can capture the full picture, here is a look at several key indicators—some suggesting continued growth, while others hint at a possible downturn.

Growth and Demand

Most recessions are marked by a significant decline in gross domestic product (GDP). However, this has not yet occurred and does not seem imminent. Second-quarter growth was 2.8% on an annualized basis, double the rate of the first quarter, matching the average growth rate over the past six quarters and pre-pandemic years.

The composition of growth is shifting, but a measure that Fed Chair Jerome Powell uses to gauge underlying private-sector demand—final sales to private domestic purchasers—remained at 2.6% in the second quarter, consistent with its average over the last year and a half and similar to pre-pandemic rates.

Services Sector Strength

The Institute for Supply Management's services activity index moved back into expansion territory, with new orders and employment both rebounding. A comparable measure from S&P Global, covering two-thirds of U.S. economic activity, stayed near a two-year high in July.

According to Chris Williamson, chief business economist at S&P Global Market Intelligence, "The July surveys indicate the economy is growing at the start of the third quarter at a rate comparable to GDP rising at an annualized 2.2% pace."

Cooling Inflation

Interest rates remain high because inflation surged in 2021 and 2022 and has been slow to decline. While the year began with an unexpected inflation spike that delayed potential rate cuts, recent data show inflation approaching the Fed's 2% target, which could soon allow for rate cuts. However, investors worry the Fed may have waited too long to shift focus from inflation to employment.

Job Market Signals Recession?

U.S. employers have slowed hiring, adding an average of about 170,000 jobs monthly over the past three months, with only 114,000 jobs added in July, down from 267,000 per month in the first quarter of 2024, and 251,000 in 2023.

Meanwhile, the unemployment rate has risen for four consecutive months, reaching 4.3% in July, nearly a full percentage point above its January 2023 low and the highest since October 2021. Typically, the unemployment rate does not stabilize until the Fed cuts interest rates.

The Sahm rule, which states that a recession is underway when the three-month moving average of the unemployment rate rises half a percentage point above its low from the previous 12 months, has never been wrong. Claudia Sahm, the economist who created the rule, recently noted that while the economy may not currently be in a recession, "we are getting uncomfortably close."

Rising Delinquencies

The U.S. household debt delinquency rate increased to 3.2% in the first quarter, up from 3.1% in the previous quarter, according to the New York Fed. This is still below the 4.7% rate at the end of 2019, pre-pandemic. However, among credit-card borrowers who have maxed out their credit limits—often younger and lower-income individuals—delinquency rates have risen significantly. Economic strains on low-income households can ripple through the broader economy. The New York Fed will release second-quarter data on Tuesday.

Downside Surprises

Recent economic reports have frequently fallen short of economists' expectations, with Friday's weak employment data being the latest example. Citigroup's "Surprise Index" is near a two-year low, indicating diminished confidence in the Fed's ability to achieve a soft landing.

Possible Responses

The response to a potential recession now would differ from the all-out fiscal and monetary measures taken during the 2020 pandemic recession. The Fed's current policy rate, between 5.25%-5.5%, offers more room for rate cuts than in March 2020, when it was between 1.50%-1.75%. However, high U.S. government debt levels could limit the extent of fiscal stimulus available from the current or next presidential administration.

Paraphrasing text from "Reuters" all rights reserved by the original author.