Is it good for the Fed that economists have been warning of a recession coming for more than half a year, but the US consumer and labor markets are extremely strong and a recession looks far away?
More than a year after the Fed began raising interest rates quickly to curb inflation, the widely anticipated recession is still not here.
Businesses are hiring aggressively, consumers are spending freely, stocks are rebounding and the housing market appears to be stabilizing are the latest evidence that the Fed's efforts have yet to significantly weaken the economy.
The impact of the pandemic has brightened the performance of both consumers and businesses, and this momentum may be self-sustaining.
Americans are spending money on events they didn't attend during the lockdown, such as travel, concerts, and eating out. Companies are adding headcount to meet pent-up demand. The government's response to the pandemic, including low interest rates and trillions of dollars in financial aid, has also left consumers and businesses with large amounts of money and cheap debt. The inflation that also worries the Fed translates into higher wages and profits, which in turn stimulates consumption.
Many economists expect the Fed's rate hikes to cool economic and price pressures over time, triggering a recession later this year. So far, however, economic data has consistently exceeded expectations.
Job growth was particularly strong, which pumped more money into Americans' wallets. The Labor Department said on Friday that employment rose by an unexpected 339,000 in May, and the increase in the previous two months was also higher than initially estimated.
"I don't think we're in the middle of a recession," said Justin Wolfers, a professor of public policy and economics at the University of Michigan.
The National Bureau of Economic Research (NBER) is an academic research institution and the official judge of the U.S. recession. The agency analyzes a wealth of economic data to help determine whether the economy is in recession. Wolfers said most of these metrics look healthy.
The labor market is still recovering
Employers hired last month included industries such as healthcare, leisure, hospitality and government, which saw significant layoffs during the pandemic hit in the spring of 2020. State and local governments, including public schools, as well as the leisure and hospitality industries, including restaurants, hotels, entertainment, and spectator sports, have yet to return to pre-pandemic employment levels amid ongoing labor shortages.
Across the economy, job openings increased to 10.1 million in April from 9.7 million in March, far exceeding the 5.7 million unemployed in the month. The mismatch between job offers and job seekers continues to spur wage growth. Average hourly earnings rose a solid 4.3 percent in May from a year earlier, similar to the annual increases in March and April.
"I certainly didn't expect the labor market to remain strong for so long," said Carl Tannenbaum, chief economist at Northern Trust.
The job market is likely to remain tight, largely as millions of near-retirement age workers have slowly dropped out of the labor market since the pandemic began. Last month, the percentage of Americans 16 and older who were working or looking for work held steady at 62.6 percent.
$500 billion in excess savings! Consumers still have money to spend
According to a May report by the San Francisco Fed, Americans have about $500 billion in so-called excess savings. This allows them to pay for summer tours, concert tickets, and cruises in the face of rising prices, and enables companies to continuously raise prices.
Southwest CEO Bob Jordan recently said the company expects strong demand over the next two to three months, which is the window for most people to book flights. American Airlines also raised its unit revenue forecast for the second quarter, citing strong demand.
The Transportation Security Administration said more people were entering and exiting U.S. airports during Memorial Day weekend than were pre-pandemic figures in 2019.
Brett Keller, chief executive of Priceline, a travel site owned by Booking Holdings, said he was surprised by the strong demand for travel as many consumers spent more when booking flights or hotel rooms.
Keller found that round-trip fares from the East Coast to Boise, Idaho, this summer exceeded $1,000, about double the $500 a few years ago.
The elasticity of the economy complicates the Fed's interest rate outlook
It can be seen that economic activity and inflation have not slowed as Fed officials expected. Since March 2022, the Fed has raised its benchmark federal funds rate from near zero to a range of 5%-5.25%, the highest level in 16 years.
Rising borrowing costs are often first felt in interest-rate-sensitive areas of the financial market and economy, such as the stock and housing markets. For example, the S&P 500 fell by about 25% from late December 2021 to October last year due to the Fed's sharp rate hikes. But the S&P 500 has since risen about 20 percent, which is usually not the case if the economy falls into recession.
Sales of second-hand homes and new homes fell sharply last year, but have climbed since January. The shortage of homes for sale has driven the recent rise in home prices. Home builders feel more confident as the shortage of existing homes boosts demand for new homes. Residential and industrial construction companies added 25,000 jobs last month, up from an average of 17,000 jobs added each month in the previous 12 months.
These signs of recovery suggest that the Fed may need to raise interest rates further to reduce inflation to its 2% target from its current level of about 5%.
Fed officials signaled last week that they favored keeping rates steady at this month's meeting. But Friday's jobs report heightened the likelihood that they would combine that pause with a stronger inclination to restart rate hikes later this year. Fed Governor Jefferson said last Wednesday:
"The decision to keep the policy rate unchanged at the upcoming meeting should not be interpreted as meaning that we have reached the peak of interest rates in this cycle. In fact, skipping a rate hike at an upcoming meeting will allow the committee to see more data before deciding on the extent of further policy tightening. ”
For the Fed, the next interest rate decision may become more difficult. If the end of the rate hike is announced too early, then you may risk a rebound in inflation; If interest rates are raised further, they may risk a severe recession.
There are signs that rate hikes are having an impact. Companies slowed investment in the first quarter, with cuts in equipment spending particularly sharp. Average weekly hours fell to 34.3 hours last month, the lowest since April 2020, likely reflecting that businesses are cutting hours. The unemployment rate rose to 3.7% in May from 3.4% in April, and the technology-dominated information sector laid off 9,000 jobs in May.
Many economists and business executives believe that the effect of interest rate hikes is lagging behind, and that it is only a matter of time before the U.S. economy is significantly weakened. Economists surveyed by The Wall Street Journal in April put the probability of a recession in the next 12 months at more than 50 percent. They have been reiterating this view since last October, but a recession still seems far away.