Let’s not overreact to the economic slowdown

Recession fears have escalated in recent weeks along with volatility in U.S. financial markets. Volatility can undermine the confidence that fuels the main street economy’s momentum. But financial market volatility alone is unlikely to bring on a recession unless severe and prolonged. As things stand today, it’s reasonable to be cautiously optimistic that a recession can be avoided in the next several months.

Let’s take a deep breath and soberly assess the current economy and near-term outlook. After a year of strong real GDP growth in 2018, it appears that growth in 2019 has settled closer to the estimated longer-run trend rate of growth of the overall economy. Most economists see that pace of growth at around 2 percent or a little below. Official estimates of inflation-adjusted GDP growth in the first half of this year average out to 2.6 percent. There may still be revisions of the second quarter annualized rate of 2.1 percent, but first half growth seems solid. 

We are now eight weeks into the third quarter. Indicators of the rate of growth this quarter are preliminary, of course, but tracking estimates made by the Federal Reserve Bank of New York and the Federal Reserve Bank of Atlanta stand at 1.8 percent and 2.2 percent, respectively. Based on data in hand, it’s hard to conclude the economy is tanking.   

A growth slowdown was widely forecast for 2019. Growth in 2018 was likely bolstered by the tax cuts, but the growth stimulus resulting from those measures has not lasted. The slowdown we’re experiencing is largely in line with what was expected for 2019.  Let’s not overreact to such a slowdown. The right question is whether the slowdown is sharper and deeper than what was expected. So far, not. 

Meanwhile, employment conditions continue to be strong. That characterization remains valid even with the recent Bureau of Labor Statistics revision lowering the number of jobs created between March 2018 and March 2019 by half a million. Most Americans who want to work have jobs, and there is evidence that many of those who previously were discouraged and had dropped out of the labor force are returning and finding work.  Wage growth by various measures is respectable, and income gains are adding to disposable income because of low inflation. 

Importantly, consumer spending is holding up well. Consumer activity is the leading determinant of economic health in the United States. Consumers can be alarmed by financial market and trade news, but the most important factors affecting the consumer’s willingness to spend are employment security and income predictability. 

The full-employment economy we are now enjoying is the foundation of continuing consumer demand and spending. For a recession to materialize, something would have to push the consumer into a much more cautious frame of mind. The culprit would likely be a severe reversal of the now favorable employment picture — widespread hiring and wage freezes, mass layoffs, job loss, rising unemployment. Current circumstances contrast strongly with such a picture. Sustained job gains are supporting consumer confidence.

To sustain the economy’s expansion, confidence levels are pivotal. Readings of consumer confidence have been high for much of this year and last. Consumer sentiment indexes have shown monthly ups and downs, and the two major indexes have sometimes produced contradictory signals, but on balance, consumer confidence remains healthy. 

Business confidence is more varied. Business fixed investment, a manifestation of confidence and optimism, has been a weak element in the GDP equation for several months. That said, the Small Business Optimism Index of the National Federation of Independent Business, an organization representing a few hundred thousand small businesses across the country, rose in July and continues upbeat. 

Uncertainty corrodes confidence, and uncertainty seems to have risen in recent months.  Perceived risks are front of mind among investors and business executives. Global demand and economic output, particularly manufacturing output, are slowing. Financial conditions are extraordinarily soft in several countries as evidenced by negative interest rates. Debt levels are generally high worldwide. And uncertainty about global trade is weighing on foreign economies, currency exchange rates and business investment in the U.S. and elsewhere. Trade conflicts – above all the U.S.-China conflict – are the single biggest factor contributing to uncertainty. 

The risk backdrop is darker externally than domestically. External risk factors ought not be over-weighted in the outlook, in my opinion. The overall U.S. economy is relatively self-contained compared to other major economies. Domestic demand drivers are normally more influential than international factors in this country’s economic health. 

The shape of the yield curve for U.S. Treasury securities – with long term rates below the Fed’s overnight policy rate – is often cited as a prediction of recession. While the U.S. economy may be somewhat insulated from global weakness in demand and output, U.S. financial markets, especially for Treasury securities, are the centerpiece of a tightly integrated global investment world. In a period of negative yields elsewhere, it should not be surprising that investors worldwide are stampeding to U.S. Treasury bonds. The predictive power of the yield curve under these circumstances is highly debatable.

The performance of the U.S. economy, while slowing after short-lived fiscal stimulus, is far from recession territory. The range of plausible macro-economic scenarios for the rest of this year and the early months of 2020 fans out from this current reality.

Continued expansion at a moderate pace is a very reasonable assumption notwithstanding market angst and media stoking of recession fears. But if action is to be taken to keep recession at bay, de-escalation of trade conflicts, especially with China, and finding a path to their resolution is the most potent inoculation available. 

Dennis Lockhart is former president and CEO of the Federal Reserve Bank of Atlanta and distinguished professor of the practice, Nunn School of International Affairs at Georgia Tech.