Could a recession be the October surprise that changes the election outlook?
It would be bad news for Kamala Harris. The economy, as always, is the top issue for voters, and a further jump in unemployment, which has already bounced up to 4.2 percent from 3.7 percent this year, would not help her chances of winning.
It would certainly be a surprise, because investors and economists today are almost unanimous believing we are in for a “soft landing.” The betting is that the Federal Reserve will manage to bring interest rates down and continue the push to reduce inflation, all while avoiding a recession.
The problem is that that has almost never happened.
Even ISI Evercore’s Ed Hyman, who has been warning of a downturn for more than a year, has thrown in the towel. Over the last couple of years, Hyman has been on the lookout for a recession, citing an inverted yield curve, declining leading indicators and, of course, rising interest rates.
Hyman has been ranked the No.1 economist by Wall Street for 43 of the last 48 years. He has earned that astonishing distinction by being right more than wrong, and also by responding to incoming data by updating his forecasts. That is what he is doing now, and he is doing so reluctantly.
Hyman recently wrote to clients: “History and experience say to stick with a hard landing outlook. However, the hard math that our team has reviewed says flip to a soft landing outlook.” But he doesn’t sound entirely convinced: “To say this is a difficult decision is an understatement. It feels like a bold moment to go soft landing.”
Bold, indeed — the last thing Hyman wants to do is ditch his recession forecast in the teeth of a weakening economy. However, he is responding to a slew of data that shows the labor market softening but not yet collapsing.
Yes, job additions are falling, the number of jobs available has dropped and workers are more pessimistic about finding new jobs. And yes, the unemployment rate has moved up more than a half percentage point, which often has signaled a recession. But, through it all, consumers have continued to spend.
Hyman has frequently observed that the Fed has almost never engineered a rate-hiking cycle without causing some financial distress, or at least shifting the economy into reverse. That still may be true, but the cycle this time has been delayed by the unprecedented amount of money the federal government threw at the COVID disruption. The trillions of dollars in federal cash spent to ward off a downturn pumped up personal savings to unprecedented levels and, along with rising net worth and a solid jobs market, prompted consumer spending that has consistently exceeded forecasts.
Remember that beginning in 2022, investors were almost unanimous in expecting a recession; it never materialized, thanks to the government spend-a-thon.
Now, however, that gusher of cash has slowed. Consumers have still been reluctant to cut back on spending; who, after all, wants the party to end? The result is a huge increase in borrowing and, for those whose income hasn’t gone up with inflation or are suddenly not able to find a job, rising delinquencies.
The FDIC, reporting recently on credit issues at the nation’s banks, wrote that the “credit card net charge-off rate increased again in the second quarter and was the highest rate reported since third quarter 2011.” That means there are more people failing to pay off their credit cards to the point that the banks write off the losses than there were during the COVID-induced downturn.
Recent data show a slowdown is finally occurring. A few days ago, the Bureau of Labor Statistics reported that there were only 142,000 jobs added in August, down from the monthly gain of 202,000 over the last year. Even worse, the June and July totals had been overstated by 86,000. So, the June additions fell to 118,000 and the revised July total was only 89,000. It is likely that the August report, too, will be revised downward. This represents a substantial weakening of the job market.
In addition, the number of full-time employees has dropped by 1 million over the last year, while workers employed part-time rose. That suggests additional fragility in the employment picture, with employers reluctant to commit to adding full-time workers.
One economist who is bucking the consensus and thinks a downturn may occur before the election is Barry Knapp of Ironsides Macroeconomics, who says he is concerned about labor demand from small businesses. He says that the Fed’s approach to cooling growth — raising rates rather than adjusting its balance sheet — has especially hit small firms, which account for some 60 percent of jobs nationwide.
He has a point. ADP reports on hiring show smaller companies’ employment growing at about one-tenth of 1 percent over the last year — essentially stall speed — while bigger firms have added workers more rapidly. The disparity is confirmed by hiring trends reported by the National Federation of Independent Business, which in its latest survey found only 13 percent of small-business owners planning to create new jobs in the next three months, down 2 points from July.
There is also evidence that individuals are having a harder time finding work. A recent Conference Board Report found “Consumers’ assessments of the current labor situation, while still positive, continued to weaken, and assessments of the labor market going forward were more pessimistic.” And the most recent JOLTS report showed the “quits” rate, which signals optimism or pessimism about the employment outlook, down substantially over the past year.
Numerous companies in their second-quarter earnings calls have cited weakening demand, especially from low-income consumers. Overall, it appears consumers are becoming more cautious.
The Fed meets next week and will likely cut interest rates by 25 basis points. A number of economists are pushing for a bigger reduction, but investors worry that a 50-basis point cut would rattle markets by suggesting the Fed sees a downturn looming. There is a lot on the line, including, perhaps, the election.
Liz Peek is a former partner of major bracket Wall Street firm Wertheim and Company.