The stock market rally that began in mid-June has been driven almost exclusively by the perception that the risk of the Fed tightening too much to combat inflation has greatly diminished. Evidence of a clear drop in inflationary pressures continues to mount: a notable slowdown in M2 growth this year (last recorded by me) here), a rather impressive sell-off in the commodity market (Chart #5 this mailbox), and a distinct cooling in the real estate market (a sharp slowdown in housing demand has pushed mortgage rates down from 6% to 5% in the last month alone). At the same time, there is little evidence to suggest the economy is in trouble. Swap spreads remain relatively low (meaning liquidity is plentiful, the opposite of what would be expected if monetary policy actually tightened). Spreads have risen only marginally (meaning the earnings outlook remains healthy), and of course job growth remains strong (July’s job creation was surprisingly strong). Either way, the debate over whether the economy is in recession is largely irrelevant. If inflation is falling, there is no reason for the Fed to raise rates until the economy collapses. If the bond market does it right (and it usually does), the Fed will likely hike rates from his current 2.5% to perhaps his peak of 3.25% in the next six months or so, and that’s not the cause of the recession. is made.
Chart 1 shows that business activity remains healthy in the economy’s very important services sector (source of about 75% of GDP). Not booming, but well above levels consistent with a recession.
Since most commodity prices have fallen significantly from their recent highs, far fewer manufacturers are reporting paying higher prices (Chart #2).
Chart 3 shows the level of spreads between investment grade and high yield corporate bonds. It is the difference between the yield on corporate bonds and the yield on comparable maturity government bonds, and is an excellent indicator of a company’s credit risk, which is highly influenced by economic and corporate earnings prospects. That’s pretty good evidence that the economy isn’t in recession. (I’m not a Biden fan, but he’s not crazy when he claims the economy isn’t in recession.)
Chart 4 is the difference between the two lines in Chart 3, commonly referred to as the “junk spread”. Today, junk bonds (corporate bonds rated below investment grade) are priced at a fairly modest level of risk to the economy. If we were in a typical recession, they would be significantly higher.
Chart 5 compares the number of jobs in the private and public sectors of the economy. Private sector employment has now fully recovered to pre-COVID levels, but has yet to improve significantly. Without the Covid shutdown, it could be at least 3-5 million higher.By contrast, public sector jobs he hasn’t grown in over a decade. That’s progress in my book. Private sector jobs are much more productive than public sector jobs.
Chart 6 shows the level of the private labor force, the percentage of the population that is of working age and willing to work. This is an excellent example of failure to thrive. Today’s workforce is at least 18 million fewer than it would have been with other incentives. A small increase in the number of people working or willing to work translates directly into subpar growth across the economy (most small business owners say one of their biggest problems is filling job vacancies). continue to report that it is not possible).
The situation could get better, but it could also get worse.
Editor’s note: The summary bullet points for this article were chosen by the editors of Seeking Alpha.