The American economy seems to be slowing down and nominal earnings growth appears less than inflation but the US seems to be enjoying full employment. What could be the causes? Or is it just that lags in reporting that cause this strange phenomenon? What possible implications could it have for investment?
Recessions are technically about falling Gross Domestic Product but the pain most people feel is a lack of job security
“It’s a recession when your neighbor loses his job; it’s a depression when you lose your own” Harry S Truman
Here’s Jerome Powell discussing how unemployment is so low that it makes you question the weak GDP numbers
“If you think about what a recession really is, it’s a broad-based decline across many industries that’s sustained for more than a couple of months, and there are a bunch of specific tests in it and this doesn’t seem like that now. What we have right now doesn’t seem like that and the real reason is that the labor market is just sending a strong, a signal of economic strength that it makes you question the GDP data.”
Link here to the question from Nancy Marshall Genzler at 44:41 FOMC Press Conference, July 27, 2022
For US recessions there’s a committee that determines whether they have occurred
The National Bureau of Economic Research (NBER) Business Cycle Dating Committee does this job
Business Cycle Dating Procedure: Frequently Asked Questions | NBER
“The NBER’s traditional definition of a recession is that it is a significant decline in economic activity that is spread across the economy and that lasts more than a few months. The committee’s view is that while each of the three criteria—depth, diffusion, and duration—needs to be met individually to some degree, extreme conditions revealed by one criterion may partially offset weaker indications from another.”
“For example, in the case of the February 2020 peak in economic activity, we concluded that the drop in activity had been so great and so widely diffused throughout the economy that the downturn should be classified as a recession even if it proved to be quite brief. The committee subsequently determined that the trough occurred two months after the peak, in April 2020.”
“An expansion is a period when the economy is not in a recession. Expansion is the normal state of the economy; most recessions are brief. However, the time that it takes for the economy to return to its previous peak level of activity may be quite extended.”
The NBER Business Cycle Dating Committee typically waits 4 to 21 months to make a recession “trough” judgement, again their FAQ states
“Our determination of the trough date in April 2020 occurred 15 months after that date, in July 2021. Earlier determinations took between 4 and 21 months. There is no fixed timing rule. We wait long enough so that the existence of a peak or trough is not in doubt, and until we can assign an accurate peak or trough date.”
For the UK it is defined as two successive quarters of negative real GDP growth
What characterises a US recession is a period of rapidly increasing unemployment
It’s the rate of change which matters rather than the starting level
You can see that on this graph where recessions are the blue shaded bars
The starting level varies slowly over time e.g.
1975-1990 period the average rate of unemployment was 7.0%
1948-1970 period the average rate of unemployment was 4.7%
1948-2022 average is 5.7%
Maximum employment is defined by the Federal Reserve as follows
Maximum employment is the highest level of employment or lowest level of unemployment that the economy can sustain while maintaining a stable inflation rate
Link The Fed – What economic goals does the Federal Reserve seek to achieve through its monetary policy?
The non-accelerating-inflation rate of unemployment (NAIRU) is estimated by the Congressional Budget Office (amongst others) but is unobservable i.e. a guess
“The natural rate of unemployment (NAIRU) is the rate of unemployment arising from all sources except fluctuations in aggregate demand. Estimates of potential GDP are based on the long-term natural rate. (CBO did not make explicit adjustments to the short-term natural rate for structural factors before the recent downturn.)”
Labour market slack = unemployment rate – NAIRU
Unemployment is less than NAIRU: a tight labour market (inflationary)
Unemployment is greater than NAIRU: slack in the labour market (disinflationary)
It is usually the case that recession starts with full employment e.g. it happened in 1949, 1953, 1954, 1957, 1960, 1970, 1973, 1974, 2001, 2008, and 2020
The best real-time recession indicator in the US is the Sahm indicator which uses the unemployment rate
Smooth unemployment over a three month window
Calculate the minimum of that smoothed rate over the last 12 months
When the 3 month average unemployment rate exceeds its 12 month minimum by 0.5 percentage points that’s a recession
In June 2022 the 3 month average of the unemployment rate for the last twelve months has been as follows
5.7, 5.5, 5.1, 4.83, 4.5, 4.23, 4.03, 3.9, 3.8, 3.67, 3.6, 3.6
The minimum over the last twelve months is 3.6%
So currently the 3m average minus its 12m minimum is 3.6% – 3.6% = 0!
On July 2022 the US is far from a recession by this measure but it’s just a rule so it could be wrong
As we don’t know whether we’re in a recession until well after it’s happened it’s difficult to use it is as a guide to investment
If we get an earnings recession this is usually a period of equity market falls but usually the equity market starts to recover before the recession (earnings or GDP) bottoms so this isn’t a good timing indicator