Is America on the Verge of a Recession?

This is the lead story for the latest edition of The Rising Tide. Subscribe on Substack (not LinkedIn) for full access. The first month is free. https://barberd.substack.com/

Recent economic indicators suggest that storm clouds might be gathering. The unemployment rate has climbed significantly from its recent lows, a trend that has often foreshadowed recessions in the past.

Traditional metrics indicate that current interest rates may be one to two percentage points too high, exerting downward pressure on economic growth.

Additionally, the yield curve has inverted, with long-term Treasury yields falling below short-term ones, signaling investor expectations of an economic downturn and a likely need for the Federal Reserve to implement significant rate cuts.

However, while some data points to potential trouble ahead, the broader economic landscape paints a picture of a gradual slowdown rather than an abrupt crash.

The unemployment rate rose to 4.3 percent in July, the highest level since 2021, and global stock markets briefly tumbled before staging a partial recovery.

High interest rates have steadily cooled the labor market since unemployment reached a historic low in April 2023. This cooling effect has, in turn, slowed wage growth and shaken consumer confidence. Some companies, like McDonald’s, have reported disappointing sales figures, which could be seen as a sign of weakening consumer demand.

Continued Economic Strength

Yet, other sectors of the economy continue to show resilience. Gross Domestic Product (GDP) growth in the second quarter of 2023 reached an annualized rate of 2.8 percent, which is above the long-term trend. Estimates for the current quarter suggest that GDP growth could comfortably exceed 2 percent, signaling ongoing economic activity.

Several indicators of consumer behavior, such as restaurant bookings, air travel, and tax collections, also point to continued economic strength. Despite the rising unemployment rate and some signs of consumer belt-tightening, American households have shown remarkable resilience.

Consumer spending, which accounts for about 70 percent of the nation’s GDP, remains steady. This spending has been a crucial driver of economic growth, particularly in sectors like dining, travel, and entertainment, which have seen sustained job creation.

Even as some consumers opt for more affordable groceries, vehicles, and other essentials, the overall level of consumer expenditure has remained robust, fueling the broader economy.

Interest Rates Falling

Adding to this nuanced picture is the behavior of long-term interest rates, which have been falling in response to growing economic uncertainty. This decline in long-term rates is already acting as a preventive boost to the economy, further intensified by nervous investors moving into bonds.

Surveys of banks suggest that credit conditions may be easing somewhat, providing additional support to the economy. The Federal Reserve is widely expected to begin cutting its policy interest rate as early as September, aligning with market expectations and potentially preventing a deeper downturn.

This anticipated rate cut is already reflected in lower rates for mortgages and credit card debt, which could help sustain consumer spending and economic activity in the near term.

Influencing the Presidential Election

The performance of the economy in the coming months will heavily influence the Democrats' chances in the upcoming presidential election. An outright recession could spell disaster for Kamala Harris, but even a modest economic slowdown could weaken her position and bolster Donald Trump.

Even without a recession, Harris faces formidable challenges. Voters might not fully credit the Democrats for the economic boom of recent years, but they could easily blame her if the economy falters. On paper, Harris should be able to campaign on the Biden administration’s economic achievements, such as a 9.4 percent increase in median real earnings since 2016.

Swing states like Pennsylvania have enjoyed lower inflation and unemployment rates than the national average, making complaints about job losses seem unfounded. However, voter perceptions are often shaped more by partisan views than by economic realities.

Many voters rate the Democrats' economic management lower than Trump’s, despite the evidence of strong economic performance. High prices, even as inflation cools, remain a sore point for many consumers, further complicating the political landscape.

Recent stock market volatility, which Trump has labeled the “Kamala crash,” is unlikely to improve voter perceptions of the economy. The S&P 500 has dropped 8 percent from its peak, a correction that was perhaps overdue given the market’s high valuations.

Despite this decline, the index is still up 9 percent for the year, and American companies have generally exceeded profit expectations. The most significant declines have been seen not in the U.S., but in Japan, which suggests that the U.S. economy remains relatively strong in comparison to other global markets.

What Voters Think

The real threat to the Democrats lies in the underlying economic slowdown that has rattled markets and could impact voter sentiment as the election approaches. Research indicates that voters weigh recent economic performance heavily when making their decisions at the ballot box. This means that the state of the economy in the months leading up to the election could be pivotal.

Growth in real after-tax incomes has slowed significantly, from an annualized pace of 1 percent at the start of the year to about half that now. Consumer confidence, which was already low despite strong growth and job creation, has dipped even further. This dip in confidence could be exacerbated by market volatility or rising oil prices if geopolitical conflicts escalate, particularly in the Middle East.

Chances of a Recession Are Small

Nevertheless, some economists maintain that the chances of a recession within the next year remain relatively slim, suggesting that a soft landing is still within reach. “The most likely outcome is still a soft landing where the economy avoids a downturn," said Mark Zandi, Moody’s chief economist, in an interview with CNBC.

Jay Bryson, chief economist at Wells Fargo Economics, echoed this sentiment, noting that a soft landing remains his "base case" forecast, though he acknowledged the concerns surrounding a potential recession.

They emphasize the importance of the Federal Reserve lowering interest rates soon to stave off a downturn. However, the recent rise in the unemployment rate to 4.3 percent in July has led some, like Goldman Sachs, to raise their recession probability forecast to 25 percent, up from 15 percent.

Zandi estimates the likelihood of a recession within the next year at about 33 percent, nearly twice the historical average, while Bryson places the chances at 30 to 40 percent.

Spending Drives Jobes

In the midst of these economic uncertainties, American households have continued to show resilience. While some consumers have tightened their belts by choosing more affordable groceries, vehicles, and other essentials, overall consumer spending has remained steady.

This spending has been a key driver of economic growth, particularly in sectors like dining, travel, and entertainment, which have spurred job creation.

Recent economic data indicates that the economy is still on solid ground. The second quarter showed stronger-than-expected growth, with wages outpacing inflation. Retail sales in June were robust, with online sales rising nearly 2 percent, and spending at food and beverage establishments showing modest gains. Additionally, lower gas prices may be freeing up household budgets for other purchases.

As the Federal Reserve faces increasing scrutiny over its policies and their effects on households and businesses, the critical question remains: how will it steer the economy through these mounting pressures?

The path forward is fraught with challenges, but the resilience of American households and businesses suggests that a soft landing is still within reach—though the margin for error is slim. As Vineer Bhansali, founder of LongTail Alpha, a hedge fund in Newport Beach, California, told The Wall Street Journal: "It all happens slowly, and then it happens suddenly."

Other stories in this edition:

Who Is Tim Walz and What Are His Ideas on Business and the Economy?

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From Big Macs to Disney: Americans Opt for Value

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Housing Market Surpasses $1 Trillion in 8 Cities

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Apartment Loan Crisis Quietly Escalates

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Students Flock to Artificial Intelligence Programs

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Tesla Bets on Robotaxi Future; Skepticism Grows

As Tesla faces a decline in electric vehicle sales, CEO Elon Musk has been trying to persuade Wall Street that the company's future lies not in manufacturing and selling cars but in the more thrilling realm of artificial intelligence.

Empty Churches Find New Life as Unique Venues

As church attendance continues to decline across the United States, a growing number of empty churches and houses of worship are being repurposed for new uses.

News From Mexico (Where I live and work)

Mexico moved from fourth to third among the world's top automotive exporters from 2022 to 2023, according to the World Trade Organization.

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