Key takeaways
- U.S. Treasury Secretary Janet Yellen said in an interview the U.S. recession risk is downgraded
- Yellen also commented consumer spending still a risk; core CPI in May shows underlying inflation pressures still sticky
- The U.S. is faring better than Europe and the U.K. on inflation, while China’s economy shows sluggish growth
The U.S. economy might be past the worst of its inflation woes, the U.S. Treasury Secretary hinted last week. Janet Yellen, who you may recognize as a key figure from the debt-ceiling crisis, said the Fed’s crusade on inflation via raised interest rates seemed to be working – but resilient consumer spending could still be a risk factor. There’s a delicate dance afoot, but the U.S. gets the gold star compared to other major economies. Let’s get into it.
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What did Janet Yellen say?
Speaking to Bloomberg News at a conference in Paris, U.S. Treasury Secretary Janet Yellen said she thought the risk of a recession in the U.S. has come down thanks to the work the Fed has been doing with monetary tightening, which has caused a financial squeeze for households and businesses.
Yellen pointed out the “resilience of the labor market, and inflation is coming down” but warned caution against any early victory celebrations. “I’m not going to say it’s not a risk, because the Fed is tightening policy,” she said; the Fed is largely expected to introduce more rate hikes after hawkish comments from Fed chair Jerome Powell at the June meeting.
“Inflation has really come down a lot — and there’s more in the pipeline,” Yellen said in an ominous reminder that it’s too early to celebrate yet. Yellen’s comments and Powell’s congressional testimony last week weren’t enough to lift spirits on Wall Street: the S&P 500 futures declined by 0.5%, Nasdaq 100 futures fell 0.7% and the Dow Jones futures closed 0.4% lower.
How is the U.S. economy faring?
Despite the overwhelming caution from Yellen and Powell, things are brightening for the U.S. economy. The Fed’s crusade against inflation took interest rates from 0.1% in 2021 to a guidance of 5% to 5.25% – a massive increase in a relatively short amount of time that would always cause some financial pain.
May’s headline inflation came in at 4%, lower than the 4.1% expected and a large decrease from the 4.9% figure we saw in April. Inflation peaked at 9.1% last summer.
The jobs market has also shown remarkable resilience given the interest rate hikes. In May, the US jobs growth was almost double the predicted strength, with 339,000 non-farm payrolls added to the economy compared to the anticipated 195,000. Crucially, wage growth also ticked downwards; month-on-month wage growth fell to 0.3%, bringing the annual basis to 4.3% and avoiding the dreaded inflation-wages spiral.
Housing has also bounced back. Housing starts, a measure of new homes construction, hit a seasonally adjusted annual rate of 1.63 million in May, beating Wall Street’s forecasts of 1.4 million. Home sales in May were down 20% compared to last year, but house prices have stayed relatively stable across the national index due to low inventory.
What are the risk factors?
During the interview, Yellen said spending was an issue and that “We probably need to see some slowdown in spending in order to get inflation under control”. The latest U.S. CPI report saw core inflation at 5.3% in May, down from 5.5% in April; shelter and used cars and trucks were the two biggest contributors to increases, while the food index increased by 0.2%. All of this suggests that core inflation is on a knife’s edge and could go higher if the underlying pressures aren’t resolved.
While unemployment has been at record low levels in the last 12 months, it’s still a delicate situation that the Fed keeps a close eye on. If the unemployment rate rises nationally, it could indicate a recession is here; we’re already seeing this happen at the state level, with California‘s unemployment rate at 4.5% compared to the national average of 3.7%. Equally, if interest rates continue to rise and become too punitive, businesses could cut back on hiring and we could see a dramatic drop in non-farm payrolls added each month.
March’s banking crisis is another reminder that punitive rate increases could cause more regional banks to topple; this year, the SPDR S&P Regional Banking ETF is still down 32%.
The global inflation picture
Putting things into perspective, the U.S. economy is faring better than most, if not all, other developed global economies after the global pandemic lifted inflation pretty much everywhere.
New data from S&P Global found that economic activity in the Eurozone, which holds 20 European countries, has slowed to a glacial pace. The purchasing managers index declined to 50.3, a five-month low, led by France’s worker strikes and Germany’s recession. However, S&P said the data reflected a “marked cooling of inflationary pressures,” which will give the European Central Bank some hope.
Things are even worse in the U.K. Headline inflation held steady in May at 8.7%, the worst of any G7 country, while core inflation accelerated to 7.1% – the highest level in 30 years. The Bank of England, in an attempt to show strength, surprised analysts by increasing interest rates by half a percentage point to 5%, causing misery for millions of homeowners coming off of short-term fixed-rate mortgages while food inflation and energy bills remain sky-high.
Everyone thought China’s economy would bounce back after re-opening from strict pandemic lockdowns, but the recovery hasn’t been as enthusiastic as hoped. China’s GDP growth is expected to be 5% rather than the 6% previously forecast, and last week the Chinese government cut lending rates in a bid to boost the sluggish economy.
The bottom line
Yellen and Powell are right to be cautious: with Wall Street hanging onto every remark they make, they can’t appear to be too optimistic and risk derailing months of hard work with battling inflation. That being said, most markers are heading in the right direction. If the Fed can balance the jobs market, core inflation pressures and unemployment, we could see the fabled ‘soft landing’ it’s been after from the start.
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