Democrats are euphoric. Talking to themselves in their closed loop, they believe they will continue to control the Senate after the November midterm elections. With just a little bit of luck, they might keep the House. Democrats presently inhabit la-la land.
Some Democrats interpreted Friday’s economic data as newly positive, believing it consistent with an economic slowdown but not a recession. That view is wrong.
The primary problem is that this Pollyanna economic view focuses overly on moderately strong employment growth, slowing wage growth, and an increase in the labor participation rate. However, the optimists ignore the very tight labor market. Because of pandemic deaths, there is a 3.5 million person shortfall in the labor force. There is little to no slack in the labor force. And while wage growth did slow for the month to an annual rate of 3.7%, wage growth over the past three months is running at 4.4%, a rate not consistent with the Federal Reserve’s 2% inflation target.
More importantly, the more accurate Atlanta Federal Reserve wage tracker and the most recent information on the employment cost index make dire reading for anyone believing in a soft landing story. The three-month median average of wage growth approaches 7% with no sign of rolling over, which is not surprising given the very tight labor market. As for the employment cost index, it, too, is increasing at an annual rate of almost 7%. The Fed wants the employment cost index to fall to 3.5%, a level consistent with stable inflation. On a secular basis, national productivity grows at an annual rate of 1% to 1.5%. Wages drive inflation.
To achieve its goal, the Federal Reserve must thus continue to raise rates aggressively, another 150 basis points and more. Most economists believe that underlying embedded inflation is running at about 4.5%. To slow the economy sufficiently to reduce wage inflation, the federal funds rate must rise above 4.5%.
Put simply, the Fed has a high hill to climb. For just one example, take professor Larry Summers, who
suggested
that to bring wage growth down to 3.5%, the unemployment rate must rise to 6%. That level of unemployment would create considerable slack in the economy.
We should also watch the housing market.
This economic sector leads overall economic activity. Housing, including refurbishing and utilities, accounts for 20% of GDP. But the housing sector is crashing. The St. Louis Federal Reserve Bank chart below is important. It clearly demonstrates that the housing sector is in recession year over year. When the housing sector goes into recession, the broader economy will very likely follow.
St. Louis Federal Reserve Bank
Again, the devil is
in the data
. Real prices for housing, adjusted for inflation, are down over 10%. New home sales are down 29.6%. Single-family housing starts are down 18.5%. Mortgage purchase applications are down 23%. The path to an economic recession runs through housing. The Fed raises interest rates, which drags mortgage rates higher. Home sales fall. Inventories of homes for sale increase. Home builders reduce construction and lay off employees. Demand for consumer durables falls. Manufacturers of durables reduce production and reduce head count. A negative feedback loop is created.
Here are a few markers that the economy is actually going into a recession. First, monthly job creation below 50,000. Currently, the economy is generating over 300,000 new jobs a month. Second, an increase in the personal savings rate from the current 5% to the more typical 7%. Third, continued pressure on real personal income, which is down for 18 consecutive months. Fourth, a fall in services consumption. Consumption is 70% of the economy. The largest part of personal consumption is services. When the public consumes fewer services, the unemployment rate will rise, and the economy will experience a hard landing.
Tough times likely wait ahead.
James Rogan is a former foreign service officer who later worked in finance and law for 30 years. He writes
a daily note
on finance and the economy, politics, sociology, and criminal justice.
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