US Economy Careens Between Glee and Gloom With Each Data Release

Former White House economist Jason Furman admits that he, too, is baffled by the contradictory signals. “There’s so much uncertainty and confusion,” says the Harvard professor. Perhaps it shouldn’t come as a surprise that even the experts can’t get a clear read. After all, we’re still grappling with a once-in-a-century pandemic and its economic aftershocks. Add to that the first major war in Europe since 1945, a 40-year-high inflation rate, and the biggest Federal Reserve interest rate increase since 1994, and it’s no wonder the path ahead is uncertain.

With the second half of 2022 under way, now is a good time to take stock of what we know (or at least think we know) and what we don’t know about this puzzling economy.

Growth is slowing significantly. But that’s to be expected: Gross domestic product jumped 5.7% last year, its fastest pace since 1984, powered by an assortment of government programs—stimulus checks, extra unemployment benefits, an enhanced child tax credit—that are no more. Still, the deceleration has been sharper than anticipated. The International Monetary Fund on July 12 cut its forecast for US growth this year to 2.3%, down from its April prediction of 3.7%.

Blame for the markdown goes to skyrocketing inflation and the Fed’s tightening of monetary policy in response. Driven in part by Russia’s invasion of Ukraine, higher prices for gasoline, food, and a passel of other products are squeezing household budgets—even those still padded by last year’s government support. The Fed’s repeated interest-rate increases have undercut the stock and housing markets. That leaves the economy more vulnerable to outside shocks, such as a renewed oil price spike or a downturn in Europe, a major destination for US exports, especially as the pandemic’s pent-up demand for travel abates.

The US isn’t in a recession—at least not yet. The working definition for a recession is two consecutive quarters of negative growth. Yes, GDP contracted 1.6% in the first quarter, and the Atlanta Fed’s economy tracker has it shrinking again in the second. (A preliminary estimate of second-quarter GDP will be released on July 28.) But hold on. Domestic demand was actually so strong in the first quarter that it sucked in lots of imports. The way GDP is calculated, that ends up as a big negative for growth.

What’s more, the official arbiter of US recessions—a committee of private economists working under the auspices of the nonprofit National Bureau of Economic Research—focuses on a slew of statistics along with GDP in determining whether a downturn has begun. And many of those, including monthly data for payrolls and industrial production, aren’t flashing red.

On to the unknowns: A big one is how the slowdown will affect inflation, which has repeatedly defied policymakers’ predictions that it will soon peak. “I think we understand better how little we understand about inflation,” Fed Chair Jerome Powell said on June 29. With a downshift in growth, forecasters are again looking for inflation to moderate after it clocked in at an eye-popping 9.1% in June. And there are signs it eventually might. Gasoline prices are falling as Americans cut back on driving. So are commodity prices such as corn, wheat, copper, and zinc. Freight costs are down, too.

But inflation could well prove sticky. The still-tight jobs market will keep upward pressure on wages—businesses’ biggest cost. Inflation expectations are shifting higher after a year of accelerating price hikes. That could prompt workers to press for higher pay increases in the future and spur companies to push through yet more price hikes to compensate for rising payroll costs, leading to a wage-price spiral like the one that helped sustain inflation in the 1970s.

How will the Fed respond to an ebbing economy? Powell and his colleagues have made no secret of their desire to use higher interest rates to curb demand and douse inflation. Since jacking up the key short-term rate by three-quarters of a percentage point in June, half of the 18 members of the Federal Open Market Committee have publicly backed another similar-size increase this month. Yet in the wake of June’s inflation number, some traders are betting the FOMC will go even bigger and raise rates by a full percentage point.

Policymakers have signaled their determination to keep tightening until they get results, with Powell declaring that they want to boost rates to levels that clearly restrict growth. But such tough talk is easy when the labor market is strong. As unemployment starts to tick up, the Fed’s resolve will be put to the test. How it responds will go a long way in determining whether the US tumbles into a recession or skirts one. It could also help decide how much inflation Americans will end up living with in the years ahead.

Of course, there are even bigger known unknowns outside the immediate economic sphere. A broadening of the Russia-Ukraine conflict could clobber growth—and push up inflation. The emergence of a new, more virulent strain of Covid-19 would also turn things upside down, again.

It’s not pleasant, but more whiplash likely lies ahead. Powell, for his part, has said the Fed will need to be nimble in responding to the incoming data. Companies, consumers, and investors will have to be, too.

More stories like this are available on bloomberg.com

©2022 Bloomberg L.P.