Is the US in recession and does it matter?
There's a heated debate over whether the US is in recession or not. But why does it matter? John Stepek explains
The US is in recession. Or is it?
There appears to be a suddenly higher level of confusion around the definition of recession.
There is, of course, a lot of politics around this. The Democrats would rather not face mid-term elections in November with headlines talking about a recession, so they’re keen to play it down. Their opponents are keen to play it up. Hence the vehemence of the debate.
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
But as I’m not an American voter, I don’t care about the political aspect of this. And if you don’t care, it’s possible to see both sides.
If you take the widely-used shorthand for a recession to mean two quarters of negative GDP growth then the US is indeed in a “technical” recession. In the first three months of the year, GDP fell by 1.6% annualised. Then in the second three months of the year, it fell by 0.9%. Simple.
But as Eoin Treacy notes on FullerTreacyMoney.com, “there are some important mitigating circumstances”. Unemployment is not rising sharply, and personal consumption spending remained positive. These are not usually things which go hand in hand with recession.
And the economy as a whole is weird right now. The traditional cycles have been knocked out of synch by the extraordinary actions taken during the global pandemic. Those actions came on top of a generally extraordinary decade following the financial crisis in which interest rates plumbed never-before-seen depths.
It’s no wonder that amidst all that it’s getting harder to tell what’s going on.
The direction of travel is certainly recessionary
A more useful question for investors is probably this: does it matter if the US is “officially” in recession? The answer to that is “not really”.
What really matters is the direction of travel. And on that front, it’s pretty clear that things are slowing down.
Employment remains high, yes. But employment is a lagging indicator, and this has probably only been exacerbated by the chaos created by lockdowns. What happens is that companies see demand booming, and then hire more people to keep up – hence employment lags on the way up.
And then when demand slows down, it takes a little while before companies decide to freeze hiring, then start laying people off. We’re already seeing jobless claims starting to pick up. So it’s possible that employment has now peaked in the US.
So on that score, even if there isn’t an official recession just now, it does seem like it’s only a matter of time.
What does this imply in turn? Well, markets don’t really mind the idea of there being a recession at this point. Why not? Because the Federal Reserve is looking to take the heat out of the economy. Or more specifically, it wants to see inflation fall.
An economic slowdown should help with that because if demand for workers is lower, then pressure on wages will be lower. And if the economy slows down, then demand for other things which have been going up in price – energy etc – is likely to drop off as well.
From the investor’s point of view, if the economy slows down, and inflation drops off as a result, then the Fed will stop raising interest rates, and everything can be off to the races again.
The big risk remains a 1970s-style outcome
The problem there is that markets might be getting ahead of themselves. Crushing inflation might take a bit more than simply raising interest rates to 2.5%, particularly when inflation is sitting at above 9%.
As I’ve said already, the big wildcard here is energy prices. We all need energy. So high energy prices mean we have less money to spend on other things. In effect, high energy prices act similarly to rising taxes or rising interest rates – they squeeze demand.
As a consumer, if your electricity bill goes up (and I’m sure we’re all only too aware that this is exactly what’s about to happen for most of us in the UK) then you have to either cut back elsewhere, or you have to ask your employer to increase your wages, in which case the money comes out of your employer’s profits (and thus decreases the amount going to shareholders).
You can reduce energy prices by using less. But if the reason you are using less is because you are also doing less – eg because you’re in a recession, you’ve lost your job, and you are no longer driving to work, say – that’s not positive.
You can reduce energy prices by producing more. But at the moment this doesn’t seem to be happening for a wide range of reasons, from oil producers of all kinds enjoying higher prices to ongoing pressure on fossil fuel usage.
You can reduce energy prices by becoming more efficient – doing more with less. Increasing efficiency has been a hallmark of developed world energy usage for decades now and it’s an excellent thing – this is productivity enhancing. But we’re at an odd situation just now where the impetus behind the energy transition is to – temporarily at least – switch to less efficient forms of energy production so as to decrease carbon emissions.
In short, I’d feel a lot more upbeat on the outlook if energy prices start to come down. Otherwise, there’s a real risk we end up with full-on stagflation – weak or non-existent growth; stubbornly high inflation; and central banks that are caught in the middle of it all. Just like the 1970s – which is, incidentally, the last time we had these types of confusing “are they, aren’t they” recessions.
Sign up to Money Morning
Our team, led by award winning editors, is dedicated to delivering you the top news, analysis, and guides to help you manage your money, grow your investments and build wealth.
John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.
He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.
His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.
-
The best houses for sale with wildflower meadows
The best houses for sale with wildflower meadows – from a 1770s mill house in Petersfield, Hampshire, to a cottage in Fittleworth, West Sussex
By Natasha Langan Published
-
Will a Santa Rally bring festive cheer to investor portfolios this year?
Investors will be hoping for a seasonal stock market boost in December
By Marc Shoffman Published
-
UK wages grow at a record pace
The latest UK wages data will add pressure on the BoE to push interest rates even higher.
By Nicole García Mérida Published
-
Trapped in a time of zombie government
It’s not just companies that are eking out an existence, says Max King. The state is in the twilight zone too.
By Max King Published
-
America is in deep denial over debt
The downgrade in America’s credit rating was much criticised by the US government, says Alex Rankine. But was it a long time coming?
By Alex Rankine Published
-
UK economy avoids stagnation with surprise growth
Gross domestic product increased by 0.2% in the second quarter and by 0.5% in June
By Pedro Gonçalves Published
-
Bank of England raises interest rates to 5.25%
The Bank has hiked rates from 5% to 5.25%, marking the 14th increase in a row. We explain what it means for savers and homeowners - and whether more rate rises are on the horizon
By Ruth Emery Published
-
UK wage growth hits a record high
Stubborn inflation fuels wage growth, hitting a 20-year record high. But unemployment jumps
By Vaishali Varu Published
-
UK inflation remains at 8.7% ‒ what it means for your money
Inflation was unmoved at 8.7% in the 12 months to May. What does this ‘sticky’ rate of inflation mean for your money?
By John Fitzsimons Published
-
VICE bankruptcy: how did it happen?
Was the VICE bankruptcy inevitable? We look into how the once multibillion-dollar came crashing down.
By Jane Lewis Published