Fears of recession puts pressure on the Fed
For a long time, it was considered fairly certain that the US economy would achieve a soft landing. However, following unexpectedly weak labour market data for July, fears of a potential recession are growing. Analysts now expect the Fed to not only implement its first rate cut in four and a half years in September, but also to potentially reduce rates more significantly. The CME Group's FedWatch Tool now suggests with a high degree of certainty that the Federal Open Market Committee (FOMC) will lower the target range for the federal funds rate by 50 basis points in September. Economists also anticipate that the Fed may loosen monetary policy more aggressively than previously expected by the end of the year.
The emotional rollercoaster in the markets and among economists has been ongoing for over six months. The economy started the year relatively weak, with an annualised growth rate of 1.4% in the first quarter. Economists grew concerned that the Fed's restrictive monetary policy might stifle growth. But easing inflation and solid growth sparked cautious optimism. The annualised GDP growth rate for April to June increased by 2.8%. Meanwhile, the core PCE price index, the Fed's preferred measure of inflation, was at 2.6% in June, only 0.6 percentage points above the Fed's inflation target.
Two job market reports dampened the economic outlook. The labour market service provider Automatic Data Processing (ADP) reported only 122,000 new hires in the private sector for July, while economists had expected at least 150,000. The shock came from the Labor Department's report, which indicated just 114,000 new jobs outside of agriculture. The unemployment rate also rose from 4.1% to 4.3%, reaching its highest level since October 2021.
Signs of a recession
Economist and Nobel laureate Paul Krugman commented in the New York Times that the economy is now „pre-recessionary“.
One indicator of a possible downturn is the rule named after economist Claudia Sahm. According to this rule, an increase in the unemployment rate by 0.5 percentage points within six months suggests an impending recession. Since January, the US unemployment rate has risen by 0.6 percentage points. While not all analysts believe the recent data necessarily signals an economic downturn, most agree that the Fed has waited too long to adjust its interest rate policy.
Criticism of the Fed
Some economists refer to the Taylor Rule from 1993, which suggests that an interest rate 2 percentage points above the annual inflation rate would create conditions for achieving potential growth. According to this rule, the Fed's interest rate is currently 170 basis points too high.
The critical question now is: How often and to what extent will the Fed ease monetary policy by the end of the year? Austan Goolsbee, President of the Federal Reserve Bank of Chicago, has indicated that the Fed is cautious. „We would never want to overreact to numbers from just one month“, Goolsbee said.
Despite this caution, many experts believe the Fed is under pressure to act. „This was an unequivocally weak job market report“, states Enrique Diaz-Alvarez, Chief Financial Risk Officer at financial services firm Ebury. He notes the low job growth and the unemployment rate, as well as wages, which only increased by 3.6% year-over-year in July. Diaz-Alvarez expects the FOMC to lower the federal funds rate by a total of 125 basis points by the end of 2024.
Additional economic data has somewhat eased recession concerns. The mood among US service providers unexpectedly improved significantly in July. The Institute for Supply Management's (ISM) purchasing managers' index rose by 2.6 points to 51.4.
