The economy is in ‘strong shape’, Federal Reserve Chairman Jerome Powell, said last week at a forum of central bankers in Portugal. In addition to jobs, he cited strong household and corporate finances, saying the United States is “well positioned to withstand tighter monetary policy.”
However, the power of the labor market is increasingly like the glossy coating on a machine that rusts on the inside. Consider just a few key indicators:
— Economic output contracted in the first quarter by 1.6 percent year on year. And while the dip was originally portrayed as a fluke, it doesn’t look like that anymore. The Federal Reserve Bank of Atlanta estimates that gross domestic product shrank 2.1 percent year-on-year in the second quarter ended June 30.
— Incomes don’t rise fast enough to keep up with prices, so consumers lose purchasing power. This is crucial because personal consumption makes up the bulk of economic output. Adjusted for inflation, disposable personal income fell 0.1 percent in May and personal consumer spending fell 0.4 percent.
— The University of Michigan’s consumer confidence index fell to 50 in June, its lowest ever recorded.
— The prices of many commodities are falling, a sign that industrial buyers are cutting back in anticipation of weak demand for their products. Since the start of the year, copper futures prices have fallen 23 percent, platinum 13 percent and wood 41 percent. Oil and wheat prices are still higher than at the start of the year, but that is largely due to shortages caused by the Russian invasion of Ukraine, not strong demand. That said, even those commodities are off their highs for the year.
— Investors, who are sensitive to the risk of an economic downturn, are getting scared. The fair had been worst first half since 1970. The value of the dollar against other major currencies, which rises as people seek a safe haven from risk, is at a 20 years high† And investors have began to demand additional return for the risk of holding junk bonds, which are more likely to default in a recession.
Despite all this, the Federal Open Market Committee is… still expected to raise the target range for the Federal Funds rate, the short-term rate it controls, by another three-quarters of a percentage point at its next meeting, scheduled for July 26-27. That would bring the cumulative increase since the beginning of the year to two percentage points, an increase so rapid that it reverberates throughout the financial system. The Office of Financial Research’s US Financial Stress Index has risen to its highest since the pandemic recession.
While Americans hate inflation, there is also growing concern about its opposite, deflation, which is a broad fall in prices and incomes that is usually a symptom of economic weakness and rising unemployment. (Still a distant threat, I’d say.) Deflation makes debt heavier because you owe the same amount, but have less income to pay it off.