Bulletin
Investor Alert

Outside the Box Archives | Email alerts

May 26, 2022, 8:09 a.m. EDT

Don’t believe the hype: The economy isn’t headed toward a recession, and the Fed isn’t ‘behind the curve’ on interest rates

new
Watchlist Relevance
LEARN MORE

Want to see how this story relates to your watchlist?

Just add items to create a watchlist now:

  • X
    Renaissance IPO ETF (IPO)
  • X
    NASDAQ Composite Index (COMP)

or Cancel Already have a watchlist? Log In

By Brian Bethune

Much has been made about an imminent, full-blown recession, triggered by the unwinding of record stimulus by the Federal Reserve and resulting steep correction in stock and bond prices.

While the clearing out of speculative froth from the markets may be wrenching, there is little evidence in the investment and consumption fundamentals of the business-cycle recovery to support a dire outlook. In fact, most economists you hear from are misreading and misinterpreting information about how we got here.

I will show, below, that the massive rise in unemployment and deep contraction of the economy two years ago were little more than a blip — nothing like the tumultuous 2008-2009 crisis. And that the inflation spike will soon fade as resources are reallocated to more critical infrastructure and productive uses, and prices in the economy find an equilibrium that’s been the norm for decades.

Read: I knew Paul Volcker (who slew the Great Inflation), and Jerome Powell is no Paul Volcker

The start of the pandemic

When the Covid-19 pandemic shock occurred in February 2020, there were no structural imbalances in the economy.

There was no evidence of excess risk taking by a well-capitalized banking system, by businesses or by individuals.

But the pandemic necessitated a widespread shutdown of the economy in March and April, and the unemployment rate spiked from 3.5% in February 2020 to 14.7% in April.

There were frenzied pronouncements of a Great Worldwide Pandemic Recession. Many reputable analysts went brain dead and jumped on the doomsday bandwagon. But the second-largest economy, China, did not experience a recession, but rebounded sharply after a brief shutdown to report yearly growth of 6.5% at the close of 2020.

A misreading of the unemployment situation

But even more astounding than the poorly informed, and premature, prognosis on China, was the gross misread of employment in the U.S.

Tracking the state of the employment markets during the pandemic upheaval proved to be a daunting task. But looking at the big picture, according to the Bureau of Labor Statistics, 99.4% of the increase in unemployment from February to April 2020 — a total of 17.3 million — was accounted for by temporary layoffs, most of them legally mandated restrictions and closures.

Moreover, 85% of the temporary layoffs were reversed by October 2020, and the increase in permanent layoffs from February 2020 to November 2020 was only 2.7 million, or 1.7% of the labor force.

Contrast that reality with the 2008-2009 recession, when the increase in unemployment from March 2007 to October 2009 was 8.6 million, with less than 1 million due to temporary layoffs.

In sum, the underlying unemployment rate rose by only 1.5 percentage points, to near 5%, during the initial wave of the pandemic [BB1]  .

Applying Okun’s law — which shows the relationship between unemployment and gross domestic product — the “endogenous” decline in underlying real GDP was only 3 percentage points. The remaining 7 percentage points of the 10.1 percentage points in early 2020 was due to temporary, legally mandated shutdowns and associated temporary layoffs.

The National Bureau of Economic Research (NBER), the research organization that dates recessions, was quick to pull the trigger, announcing on June 8, 2020, that a recession commenced in March. A year later, on July 19, 2021, the NBER said the recession ended in April 2020, the shortest two-month “recession” in the history of the country.

The powerful and unprecedented recovery of employment and output since May 2020, the swift recalls of temporary layoffs, even in the face of subsequent pandemic waves, now leads to the question: Was there a “bona fide” recession in 2020?

The fiscal-monetary counterpunch

The egregious misread of the employment market, combined with negative bandwagon effects, led to the massive fiscal-monetary stimulus that was unleashed from March to May 2020. The scope and scale of stimulus exceeded that of the deep and persistent 18-month recession from January 2008 to June 2009.

The federal deficit increased from 4.6% of GDP in 2019 to 15% of GDP in 2020. That widening gap of 11.4 percentage points is the largest fiscal stimulus on record since WWII, and exceeded by a wide margin the 8.7 percentage points in the 2008-2009 recession.

The Fed’s assets more than doubled over a short time span of two years: from $4.2 trillion at the end of February 2020 to $9 trillion in the third week of March 2022.

Pathological negativity about the outlook for 2021 was amplified through the entire supply chain, as producers cut back on forecasts of product demand, and planned output rates were throttled back.

This knee-jerk reaction on the supply side was exacerbated by other disruptions, including tariffs from the previous administration, a crisis in the maritime shipping industry due to neglectful and abusive treatment of ship crews during Covid-19, and the re-emergence of regulatory constraints and roadblocks in the energy sector under the current administration. That includes the abrupt cancellation of the critical North American Keystone energy pipeline.

Speculative investments

The Fed’s action to collapse interest rates and inject liquidity did not fuel an excessive household- or business-debt expansion. But the liquidity found the path of least resistance, and exploded into the speculative gaming “parlors” of SPACs, overpriced IPOs, cryptocurrencies, “coin” offerings, meme stocks, “pay for flow” cash flows and nonfungible tokens (NFTs). It’s a familiar tune: The Fed, the Treasury and the Securities and Exchange Commission (SEC) are unable to keep up with the liquidity whirling dervishes.

We are now witnessing the consequences of those speculative excesses. The Renaissance IPO ETF /zigman2/quotes/207665280/composite IPO +2.52% is down 60% from a peak, and the Nasdaq Composite Index /zigman2/quotes/210598365/realtime COMP +0.90% of mostly growth and tech stocks is in a brutal bear market.

‘Excess employment demand’ is a myth

The jobs recovery since May 2020 has been stunning, but the “excess employment demand” narrative now being propagated by the Fed as a potential source of inflation is considerably exaggerated.

/zigman2/quotes/207665280/composite
US : U.S.: NYSE Arca
$ 30.87
+0.76 +2.52%
Volume: 144,905
July 1, 2022 4:10p
loading...
/zigman2/quotes/210598365/realtime
US : Nasdaq
11,127.85
+99.11 +0.90%
Volume: 4.11M
July 1, 2022 5:16p
loading...
1 2
This Story has 0 Comments
Be the first to comment
More News In
Economy & Politics

Story Conversation

Commenting FAQs »

Partner Center

Link to MarketWatch's Slice.