The US economy is not heading for recession, as it’s not FIRING on all cylinders!

There is currently a lot of concern regarding the US economy and its ability to withstand the collapsing price of oil and mined commodities, the Chinese slowdown, and the recent quarter (yes, quarter) point rate rise – or given the current market mood, its ability to cope with a doubling of the Fed funds rate! Whilst high yield spreads are close to recessionary levels, this is skewed by the energy sector. The manufacturing side of the economy is in clear decline, but the services sector is more significant for US growth and is performing much better (although the non-manufacturing ISM is well off its recent highs). The US yield curve is some way from being inverted, which has historically signalled recession, although it has been flattening and needs to be steeper. We think the Fed remains on track to continue raising rates as it should be focused on the data that points to a strengthening labour market.

If the outlook from an economic and industrial output perspective were grim then companies would be shedding labour in the most traditional manner, by firing people. The graph below shows that the private sector is firing the lowest percentage of the working age population in the past 15 years. This is a sign of continued labour market strength, and the low level of job cuts points to a continuing trend of healthy employment numbers.

The US economy is not heading for recession, as it’s not FIRING on all cylinders!

When analysing labour market and economic strength economists talk about the level of natural unemployment. In that context one can imagine there should be a natural rate of job cuts below which the economy cannot go. After all, there will always be some employers in difficulty, and thus requiring to shed labour. From the chart above one could infer that the natural rate is around 0.02%, meaning in this context the US labour market continues to look strong.

If the US economy was going to be pushed into recession then surely we would have had some signs by now, because oil has been in a bear market for more than a year, the Chinese stock market in a bear market for nine months, the mined commodity market in a bear market for two years, and the minor move in rates was fully anticipated (and delayed).

The economic reality is that falling oil prices help the economy, falling commodity prices are a supply rather than a demand issue, the Chinese economy is not a significant input into the US economy, and interest rates and Fed policy remain exceptionally accommodative. The stock markets, commodity markets, and the economy do not always move in tandem. The Fed should not focus on these indicators. Its mandate is not to support the stock market or the commodity market, but to support the labour market. The Fed should therefore remain vigilant, and not get sidetracked by noise that has little effect on the long term outlook for inflation, or the short term outlook for the labour market.

The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.

Categorised as: Employment Commodities

Discuss Article

  1. mark zolotov says:

    It is true that the unemployment numbers in the US are constructive on face value but closer inspection will show that the participation rate in the US does not reflect nearly as strong an employment picture as you are painting. I would also draw your attention to the Baltic Dry Index which has fallen 96% over the past 74months. This is primarily a result of the decline of China’s economy. I am somewhat surprised that you hold that the Chinese economy is not a significant input into the US economy. I do agree with you that the Feds’ mandate is not to support the stock market nor the commodity market- but I find it perhaps more difficult to separate them from the labour market than you do.
    Lastly, I am not quite sure what it is that you are suggesting the Fed should do other than to remain vigilant.

    Posted on: 19/01/16 | 3:57 pm
    • Richard Woolnough says:

      The participation rate is indeed falling overtime, therefore implying as you suggest plenty of spare labour. The difficulty with this indicator is determining how much is cyclical or structural. This is something we have been thinking about and hope to go into greater detail about in a future blog. We probably think it is more a structural than cyclical issue.

      With regard to the Chinese economy the percentage of exports that go to China that will be reduced as a percentage of US GDP is not a significant factor to the US economy. The US is a very closed economy.

      Weakness in the Baltic freight index is of concern, and is something the team has looked at in the past . It has proven to be a decent indicator of economic health in the past, and will in the future. However in this case it may well be predominantly a function of slowdown elsewhere in the world in emerging markets, and commodities, as opposed to being led by coming weakness in the US and other G7 economies. The data in the US as reflected by the labour market remains robust, despite the externalities that paint a weaker picture.

      Posted on: 20/01/16 | 10:28 am
  2. Alfonso Savarino says:

    A pretty basic economic analysis of the US economy, with a number of simplistic qualifying statements. “China is not a significant input into the US economy”… Eh? Cheap goods from China aren’t an input? “Remain vigilant”… Against what? Inflation?

    Your analysis appears to assume that historic labour market measures remain useful barometers of the health of the US labor market. Clearly hiring and firing practices have evolved, while structural changes like a shift to part-time or contract work mean this measure will overstate the true health of the labor market. Even your chart appears biased by the last observation of a volatile series, as prior to this the trend appears to have deteriorated since 2014.

    The current global economic malaise of slow growth and deflationary pressures reflects more than just a temporary hangover from the 2007–09 balance sheet recession. Powerful structural forces are at work, the effects of which will linger for a long time. These include an ongoing overhang of debt, the peak in globalization, adverse demographics in most major economies, monetary policy exhaustion, and low financial asset returns. Investor expectations have yet to adjust to the fact that sub-par growth and low inflation are likely to persist for many years.

    With 25% of your fund invested in low yielding government bonds rather than US corporate paper, do you really believe the US economy is firing on all cylinders? Why not lend more to companies operating in this so-called robust economy?

    Posted on: 19/01/16 | 8:47 pm
    • Richard Woolnough says:

      Thanks very much for your comments. There are a variety of factors that help and hinder growth in the US economy, that vary in their significance over time. Looking through this noise to the end data that is the labour market, it is clear that unemployment is low and heading lower in the near term. Examining data that is central to the Fed’s thinking is something we find useful. We don’t discount the counter arguments, but when looking at the data in this and other blogs we have written on the subject we come to a more optimistic outcome on the future for the US labour market than many commentators. With respect to China, I meant that slowing growth there is not an issue for US GDP, as it is still growing, and US exports to China are less than 1% of GDP.

      Posted on: 20/01/16 | 1:02 pm

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