The US GDP fell 1.6% on an annualised basis in the first quarter of 2022 (calendar year), followed by a 0.9% fall in the second quarter. Two consecutive quarters of economic contraction or declining real GDP — that’s the general rule to identify a recession.
For most people though, a recession is when they start worrying about their job. Every US recession since World War II has been characterised by a slide in the GDP — or measure of economic output — simultaneously with a spike in unemployment. But this time, it is completely different.
Over the past six months, jobs have been created in the US at the rate of nearly half a million a month. There is no historical precedent for a recessionary economy to produce 528,000 jobs in a month — as the US economy did in July — and at 3.5%, the unemployment rate is the lowest since 1970.
A recession is generally understood to follow an increase of interest rates by the US Federal Reserve. Rising rates typically signal a danger of uncovering imbalances or systematic risks in the financial system, apart from dampening consumption and demand. There is also the continuing oil price shock (even though prices have eased over the last few weeks), a possible downturn in Europe if Russian natural gas supplies wind down, the economic crisis in China, and the threat from new strains of the coronavirus.
Economic contraction and unemployment typically move in tandem because they feed on each other: when there is a downturn, businesses lay off workers. As a result, people spend less money, which, in turn, dampens demand and lowers profits for businesses. So they lay off more workers, which further dents demand, and this ends up becoming cyclical.
Economic output in the US is contracting in line with the Fed’s rate-tightening. But companies are still hiring in droves, and many jobs, especially in the pandemic-hit service sector, remain unfilled. US Bureau of Labor Statistics data released on August 5 show non-farm payroll employment rose by 528,000 in July, and unemployment was down to 3.5%.

The Labor Statistics news release presents data from two monthly surveys: the household survey that measures labour force status, including unemployment, by demographic characteristics, and the establishment survey that measures non-farm employment, hours, and earnings by industry. Besides lower unemployment rates, the labour market is also showing record high ratios of new job openings to potential applicants—which points to the fact that companies are still reporting open job postings.
There are two main takeaways from the July data. One, the number of working Americans has topped the pre-pandemic number, as the economy added jobs at a three-month moving average of 437,000. Two, the unemployment rate dropping to 3.5% means it is back to its pre-pandemic low, which marks the lowest unemployment rate in half a century. Also, the total number of unemployed workers (5.67 million) was lower in July than it was in February 2020 (5.72 million).
There is a view that the strength of the labour market increases the headroom for the Fed’s rate tightening action. The other view is that given the Fed’s target to “achieve maximum employment and inflation at the rate of 2% over the longer run”, the central bank could be forced to go more aggressive in its monetary-policy tightening path to tame inflation, leading to a hard landing.
“As I see it, given the Fed’s dual mandate, the strength of the labour market only implies that it can remain more decisive in rate hikes to bring inflation down on a durable basis. This Fed tightening cycle has a long way to go with many more rate hikes due, and an economic recession in the US should thus still remain the base case for a 12-month horizon,” Viral V. Acharya, CV Starr Professor of Economics at NYU Stern School of Business and a former Deputy Governor of the Reserve Bank of India, told The Indian Express.
Fund manager Cathie Wood, in an interview with Bloomberg TV in August, said she and her team at Florida-based ARK Invest believe that the US has entered a recession, and that there are signals — including household employment metrics — that the economy is very weak. “Beyond the non-farm payrolls, if one looks at household employment — seen as a much broader base to survey of employment — it has been flat to down for the last four months,” Wood said. She linked this more to a “massive inventory glut”.
In June, Walmart, the world’s largest retailer, said it was working on controlling what it could to reduce inventory through sales and price rollbacks, while Target, another big box retailer, took a major sales hit in its May earnings call, and announced on June 7 that it would be taking steps “to downsize inventory through additional markdowns”.
There are other indicators that are looking up or staging a substantial recovery, quite out of sync with the Fed’s aggressive moves to slow the economy down. American shares, which had a torrid six months from January-June this year — the worst such period in more than five decades, with the S&P500 diving over 20% and the NASDAQ over 30% — are on a sharp rebound. Since the middle of June, the NASDAQ is up more than 20% from its low, officially entering a bull rally, while the S&P500 is up by more than 15%.
While the Fed interest rate hike is a key factor, according to Daniel Bachman, Senior Manager, Deloitte Services LP in charge of US economic forecasting, this is only part of the story. “Just because recession occurs after the tightening cycle has started does not mean that the tightening caused the recession. Recessions occur because of shocks in the economy,” Bachman said in a June forecast. Lisa Shalett, Chief Investment Officer, Wealth Management at Morgan Stanley, noted in June that while the chances of a recession ticked higher by the Federal Reserve’s latest rate hikes and hawkish forward guidance, “a recession today is likely to be shallower and less damaging to corporate earnings than recent downturns”.
Prior to the pandemic-induced 2020 recession, other recent recessions have been credit-driven, including the financial crisis of 2007-08, and the dotcom bust of 2000-01. In those cases, debt-related excesses built up in housing and Internet infrastructure, and it took nearly a decade for the economy to absorb them. By contrast, excess liquidity, not debt, is the most likely catalyst for a recession today, Shalet noted in her Global Investment Committee Weekly report of June 27.
A sharper-than-expected hike in rates in the US is bad news for emerging markets and could have a three-pronged impact. When the Fed raises its policy rates, the difference between the interest rates of the two countries narrows, thus making countries such as India less attractive for the currency carry trade. A high rate signal by the Fed would also mean a lower impetus to growth in the US, which could be yet negative news for global growth, especially when China is reeling under a real estate crisis. Higher returns in the US debt markets could also trigger a churn in emerging market equities, tempering foreign investor enthusiasm. There is also a potential impact on currency markets, stemming from outflows of funds.
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According to Neelkanth Mishra, Co-head of Asia Pacific Strategy, India Equity Strategist with Credit Suisse and part-time member of the PM’s Economic Advisory Council, as economies have opened up, supply is responding but demand has gone up well in advance. That created inflation exacerbated by what is referred to as supply chain bullwhips.
“Everyone is building an inventory. In the US in particular, this became really bad because it didn’t have the manufacturing capacity to meet the additional demand, but it had triggered that demand by handing over cash to people through a stimulus. The demand went over to China, Japan, India, Bangladesh and when the goods started hitting the US ports, they realised these didn’t have the capacity. This triggered a wage-price spiral in the US, which is the most dangerous form of inflation where people start demanding wage hikes and prices go up”.
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Anil SasiAnil Sasi is National Business Editor with the Indian Express and writ… read more

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