Weak jobs keep people worrying. Good!

The US upswing will break new ground in July, becoming the longest ever. There is a clamour saying that a recession is due and some people are worrying that it is becoming visible in the data. The yield curve has inverted and recent data have indeed been softer though by no means recessionary. Friday’s payrolls at just 75k struck some nerves but this is only just below the 100k or so that is compatible with keeping unemployment level at 3.6%. And one month’s data should always be treated very carefully. Remember April was very strong at 224k so the 2 and 3 months averages are still about 150k. Importantly, one measure we watch closely, the leading indicator has actually started rising again after several months of stagnation.

Overall the data are consistent with the slowdown we expected from over 3% growth in 2018 to about 1.5-2% this year. The one indicator that has everyone talking is that inverted yield curve. We have argued before why it is misleading but it is clearly making the Fed nervous too, even though they have also dismissed it as a good indicator. Hence the much more dovish comments from them in recent days.

Paradoxically, the fact that a recession is so widely expected makes it less likely to happen. Or at least not soon – there will be one eventually. Remember back in the early 2000s when the “Great Moderation” was supposed to have banished major recessions. Arguably it was that complacency which led to the “Great Recession” of 2008-9 as banks ramped up risk.

What causes recessions?

US recessions arise for one or more of three reasons: A pick-up in inflation which causes the Fed to tighten sharply; an oil shock; or a financial crisis (though these have been rare since the First World War). Today, inflation is well-behaved and wage growth, although it moved up in 2018, is still moderate. Moreover, with the economy slower this year wage acceleration should slow down, despite very low unemployment.

Further, our view is that there is a very good chance of productivity growth picking up from the low levels of recent years. We see new technology everywhere, except in the productivity statistics (to paraphrase Solow). An increase in the US productivity trend, for example from 1% pa to 1.5% or 2% pa, would make it easier to absorb rising wage growth without higher inflation.

Even if inflation does pick up modestly, recent Fed speeches suggest that the FOMC will be inclined to tolerate an inflation rate slightly above 2% after so many years with it running below. They are not going to jump on it. Monetary policy is still very supportive of economic growth with the Fed Funds rate well below nominal GDP growth.

An oil shock is possible if there is a major convulsion in the Middle East. But US shale oil helps to put a ceiling on oil prices these days. Finally, the risk of a financial crisis seems low. There are areas of excess such as corporate debt but the banks are not especially exposed to this and their capital and liquidity positions are much better than pre-2008. Largely because everyone is on high alert for the next recession!