Economists and market analysts have been in an ongoing debate over the state of the US economy in light of recent events. While some economists like those from The Conference Board have pointed to deteriorating economic conditions and persistent inflationary pressures, others like Mark Zandi, chief economist at Moody’s argue that the US economy is stabilizing.
“This economy is incredibly resilient, despite all the slings and arrows – despite the banking crisis, rate hikes, the debt ceiling,” Zandi said. His assertion has been echoed by Biden and other administration officials, who have claimed that “Bidenomics” has produced the “strongest growth since the pandemic of any leading economy in the world.”
In spite of this optimism, the US Treasury Department, led by Secretary Yellen, has signaled that there may be further economic disruptions and called for continued vigilance. Her warnings are shared by several key members of the Federal Reserve, who have expressed concern over rising interest rates and a growing number of firms in financial distress.
Headlines Versus Reality
The release of May’s government job figures sent mainstream media into a frenzy with headlines proclaiming that the labor market is “stunningly strong“, alleged proof that Bidenomics is working. And it hasn’t been just the media that has been quick to jump on the good news.
Several banks including Goldman Sachs and Morgan Stanley upgraded their economic forecasts for 2023 due to the job figures. Clients of Morgan Stanley were told that May’s jobs report “continues to point to a soft landing for the economy,” while Goldman Sachs lowered the risk of a 12-month recession to 25%.
But while the job figures are encouraging, they don’t tell the whole story and fail to consider potential headwinds from tightening lending conditions – something the Treasury Department and Fed appear keenly aware of.
Following the release of May’s job numbers, Secretary Yellen issued a statement warning against any early victory celebrations. “I’m not going to say it’s not a risk, because the Fed is tightening policy,” she said as a reminder that it would be a mistake to think the economy is completely out of the woods.
The Treasury Department’s stance has been echoed by several Federal Reserve members, including Fed Chairman Jerome Powell, who cautioned earlier this month that uncertainty remains elevated. The “full effects of our tightening have yet to be felt,” he said, adding that “uncertain lags” could create additional headwinds for the US economy.
Yannick Timmer and Ander Perez-Orive, who sit on the Board of Governors for the Federal Reserve, similarly sounded a note of caution. “Our results suggest that in the current environment characterized by a high share of firms in distress, a restrictive monetary policy stance may contribute to a marked slowdown in investment and employment in the near term,” they said in a note released in June.
Timmer and Perez-Orive’s warning adds to the chorus of voices cautioning that while May’s job figures were encouraging, there are still risks and potential headwinds ahead. And with the release of June’s job numbers, it appears that their warnings may have been prescient.
Gaining Perspective – A Look Through the Lens of Public Officials
The release of June’s job figures last week was accompanied by a more somber tone than the one that greeted the May figures. The jobs report showed a much weaker-than-expected performance, adding just 209,000 new jobs – nearly a third less than the 309,000 gain in May. Economists had been expecting an additional 240,000 jobs.
The divergence between May’s unemployment rate and job growth figures, which had some economists perplexed, has fallen closer to expectations in June. Month-over-month unemployment remained relatively unchanged at 3.6%, but job growth has slowed significantly indicating that the labor market is cooling.
But it’s not only the sobering job numbers that have some officials concerned. The continued tightening of lending conditions has led to increased distress among financially vulnerable US firms, an issue that the Treasury Department and Fed remain closely attuned to. And while rosy job figures often steal the headlines, the underlying risks to economic stability due to tight credit remain firmly in place.
According to Fed officials’ Perez-Orive and Timmer’s analysis, around 37% of nonfinancial firms are in distress – meaning they are close to default. With the contractionary shock of tighter lending conditions now in full swing, the potential fallout from already distressed firms could be significant. Firms that stocked up on low-rate debt prior to the Fed’s rate hikes, or those with large amounts of leverage, won’t have the same access to favorable financing. According to Perez-Orive and Timmer, the result could be a wave of bankruptcies as firms find themselves squeezed by higher interest rates.
Corporate default rates have already started to rise, and the Fed is warning that further tightening could lead to an increase in bankruptcies and job losses. But due to the lag between a shift in monetary policy and its impact on the economy, the full effect of these policies may not be seen until next year, says Perez-Orive and Timmer.
With the banking industry already on fragile footing and other major sectors like corporate real estate reeling from the impact of higher rates, economists are warning that the US could be in for a bumpy ride ahead. The Fed has signaled that at least two more rate hikes are in the cards, with the risk of more depending on how well the economy absorbs them. If this is the case, then rates would rise to levels not seen since 2001, exacerbating the risks to already distressed firms.
Even without the prospect of future rate hikes, Perez-Orive and Timmer say that “the recent policy tightening is likely to have effects on investment, employment, and aggregate activity that are stronger than in most tightening episodes since the late 1970s,” when soaring interest rates crippled the US economy. Following a barrage of rate hikes, business bankruptcies surged by over 42% in the first 10 months of 1981 when compared to the same period in 1980.
Given the share of distressed firms today and the Fed signaling that it intends to continue its tightening path, economists are expecting the trend of cooling job growth and failing businesses to continue. Fed officials are bracing for this potential downturn, and while their policies may have padded the US economy against a recession in the near term, experts have warned that a soft landing is far from assured. The lesson from history is clear: the US economy is now at a critical juncture, and only time will tell how well it absorbs the tightening of monetary policy.
Stability in the Face of Uncertainty
With the US economy facing an uncertain future, Fed and Treasury officials have cautioned that it’s important to remain vigilant and prepare for potential headwinds. Headlines often belie the full complexity of the situation, and while May’s job numbers may have given some a false sense of security, June’s numbers underscore the fact that any victory lap is premature.
In light of the Federal Reserve’s warnings of future “financial headwinds“, a growing number of Americans are turning to gold. A recent Gallup poll found that the number of Americans who think that gold is the best long-term investment has grown from 15% in 2022 to 26% today.
“Gold tends to be the beneficiary when confidence levels in both real estate and stocks are down. This is typical during times of economic recession or uncertainty, as happened around the time of the Great Recession, and is happening again today,” according to the report.
The report’s findings suggest that US citizens are increasingly turning to gold to protect their savings in the face of market volatility. The possibility of additional rate hikes and a looming recession has prompted some analysts, like those from the Wells Fargo Investment Institute, to upgrade their 2023 year-end gold price forecast and upgrade their guidance on precious metals from neutral to favorable.
Analysts have pointed out the “gold rally may have legs well into 2024,” and the yellow metal “may finally be ready for sustained price momentum.” Gold’s historical returns during times of economic distress along with its potential to protect against market volatility, have made it an attractive option for millions of Americans already. With the US economy facing a precarious future, gold’s role as a defensive asset could become even more important in the months and years ahead.