Written for Bolton by Anirban Basu, Economic Advisor to Bolton
For a time, debate regarding whether or not America had succumbed to recession was raging. On July 28th, the Bureau of Economic Analysis revealed in an initial estimate that real U.S. gross domestic product declined 0.9% on an annualized basis during the second quarter of 2022 after slipping 1.6% during the first. That satisfies a technical definition of recession, though not the official one.
But that debate became less intense when a few days later the Bureau of Labor Statistics announced that America had added 528,000 jobs in July and that unemployment had returned to its pre-pandemic level of 3.5%. Pundits and others pointed out that a typical recession involves too much supply chasing too little demand. The current situation is characterized by too little supply chasing too much demand.
That helps explain what remains the most salient aspect of the nation’s economic performance, which is inflation as opposed to recession. There has been good news in this context as well, however. According to The Federal Reserve Bank of New York’s Global Supply Chain Pressure Index (GSCPI), supply chain pressures peaked in December 2021 at their highest level during the nearly 25-year history of the data series^1. Since December, the GSCPI has declined 57.5% and is at its lowest level since January 2021, although the reading remains significantly above its historical average.
Not coincidentally, there have been indications that inflation has peaked. In July, consumer prices were roughly flat. The year-over-year increase in consumer prices was a still alarming 8.5%, but that was down from the 9.1% figure that characterized the prior month. Much of the improvement in inflation is attributable to energy price declines, though food prices in many cases continue to surge higher.
Nonetheless, financial markets have seen fit to rally in July and August under the theory that ebbing inflationary pressures will induce the Federal Reserve to tighten monetary policy less aggressively. Investors seem willing to overlook current inflation and elevated risk of recession to a period during which America’s central bank becomes more accommodative. In part because of evidence of declining inflation and improving supply conditions, there are plenty of economists who believe that the economy has not been in recession and that the Federal Reserve will be able to neatly engineer a soft landing.
Such prognostications could easily prove incorrect. While consumers continue to ratchet retail sales higher, many employers are actively striving to add to staff, and certain global supply chains have improved in fits and starts, there remains war, economic lockdowns in China, a burgeoning energy crisis in Europe, shrinking rivers, ruined harvests, and ongoing workers shortages.
In short, elevated inflation isn’t going away anytime soon as scarcity continues to characterize much of the global economy. That implies that the Federal Reserve will see fit to continue to ratchet interest rates higher, with the likelihood of recession increasing with each policy meeting. Since the early 1980s, there have been eight prior rate-tightening cycles. Six ended in recession.
^1 The GSCPI is a composite index that incorporates freight data for air, sea, and ground transportation prices as well as various Purchasing Managers’ Indices. A higher reading of the GSCPI is associated with greater supply chain pressures.