Recession Today or Endless Stagflation: What Does the Future Hold?
The comments below are an edited and abridged synopsis of an article by Michael Pento, PentoPort.com
The labour market is weakening, which is a necessary correction to address economic imbalances caused by decades of “free money” policies. Short-term pain, such as slower job growth and higher unemployment, is required to prevent runaway inflation, which would otherwise devastate the middle class.
Recent data reflects this labour market slowdown. The ADP employment report for August showed just 99,000 new jobs, well below the 140,000 forecast. Similarly, the employment subcomponent of the Institute for Supply Management (ISM) services index fell, and U.S. employers announced 193% more job cuts in August compared to the prior month. While the layoffs aren’t massive yet, they’re steadily increasing, suggesting worsening conditions. Hiring plans are also down significantly from last year.
The August Nonfarm Payroll (NFP) report further highlights the labour market’s weakness, with 142,000 new jobs created, again below expectations. The unemployment rate dipped slightly, but significant downward revisions for June and July suggest the labour market is weaker than previously reported. These trends undermine the optimistic earnings projections from Wall Street, with many analysts anticipating a 15% growth in earnings per share (EPS) for the S&P 500. However, this figure is overly ambitious given the current economic outlook, including expected slower GDP growth and rising tax rates.
Several factors suggest the U.S. economy is heading towards stagnation or even recession. Total non-financial debt to GDP has reached a record high of 260%, and debt-laden economies tend to grow slowly. Meanwhile, bank lending standards are tightening, loan demand is slowing, and leading economic indicators predict growth of just 1% for Q4. The recent normalization of the yield curve, which had been inverted for a record period, typically signals a recession within months.
Moreover, the Federal Reserve’s real funds rate has remained in positive territory for over a year, a historically significant factor contributing to economic slowdowns. The shrinking of the Fed’s balance sheet, with $2 trillion cut from the base money supply, also points to an economic contraction. In July, the Sahm rule, which indicates a recession when unemployment rises by 0.5% or more, was triggered, adding to recession fears.
Despite these warning signs, the Fed is considering rate cuts to prevent a deeper downturn. Fed Governor Chris Waller hinted at potential rate reductions following a weaker-than-expected jobs report. Waller suggested that if economic data worsens, a series of cuts may follow, signaling the Fed’s willingness to act to prevent further economic pain.
However, this approach is fraught with risks. Inflation has already eroded many Americans’ standard of living, and without decisive action, inflation could worsen, pushing more people into poverty. While a recession may bring short-term pain, it could help stabilize the economy and preserve the long-term purchasing power of consumers, which is essential to prevent further impoverishment of the middle class.
Note: As of this writing, the Fed has reduced its target range to 4.75%-5%, marking a 0.5 percentage point decrease from its previous level, which had been the highest in 23 years. The effective federal funds rate is now 4.83%, down from 5.33% on September 18, according to data from the Fed.