Powell Announces “Pivot”

Labor Day weekend is over, and the election is just over two months away. Is the U.S. economy in a recession as election season enters full swing?

There’s a mountain of data suggesting the answer is yes, or if we’re not in a recession, we soon will be. We’ll explore this data below but let’s begin with the (supposedly) most powerful force in the U.S. economy — the Federal Reserve.

On Aug. 23, Fed Chair Jay Powell gave an address to the annual Federal Reserve conference held at Jackson Hole, Wyoming. This was one of Powell’s most important speeches ever for two reasons.

First, he not only pivoted to interest rate cuts (after Wall Street having been wrong about the pivot timing for two years), but more significantly he pivoted from concern about inflation to concern about unemployment.

The latter pivot is much more troubling because it signals that a recession is upon us and the Fed may be too late (as usual) to do anything about it.

For the past two years, we have consistently written that the interest rate pivot was not on the horizon despite Wall Street predicting one beginning in late 2022 and continuing its predictions through 2023 and early 2024. We also wrote that, when the pivot did arrive, it would not be for the reasons Wall Street expected.

It would not be a soft landing or a Goldilocks narrative. It would be a hard landing and a recession because that would be the only thing that could shake the Fed out of their inflation-fighting trance. Now we’re there.

The rate pivot is coming, and the recession is too if it’s not already here. Wall Street will crash once they wake up to what the Fed is actually saying.

A Trump Tribute — Fed Style

Before looking at this double pivot on rates and unemployment, it’s worth looking at Powell’s possibly unintentional tribute to Trump. He said:

Turning to employment, in the years just prior to the pandemic, we saw the significant benefits to society that can come from a long period of strong labor market conditions: low unemployment, high participation, historically low racial employment gaps and, with inflation low and stable, healthy real wage gains that were increasingly concentrated among those with lower incomes.

Wow. Powell never said “Trump” but he was referring to the years 2017–2019 during the Trump administration and talked about “strong labor market conditions,” “low unemployment,” low inflation, “real wage gains” and improved racial comparisons in job gains.

That’s economic nirvana and it happened under Trump. Of course, Powell couldn’t go so far as to give Trump credit. He tried to claim credit for the Fed. In fact, the Fed is practically irrelevant to the conditions he described.

From there, Powell moved to the double pivot. It’s important to recall that the Fed has a so-called “dual mandate.” This consists of price stability and low unemployment. That mandate was imposed by the Humphrey-Hawkins Full Employment Act of 1978.

The Fed Is What’s Lagging

Never mind that inflation and unemployment have almost no correlation (the Phillips curve is junk science) or that those goals are often completely contradictory. Never mind that the way for government to create jobs (if that’s what you want) is fiscal policy, not monetary policy.

The politicians ordered the Fed to try anyway. The Fed never objected, because what bureaucracy doesn’t like more power? We’ve been living with bad policy results ever since.

In that policy context, it’s worth looking at Powell’s remarks at length:

Today, the labor market has cooled considerably from its formerly overheated state. The unemployment rate began to rise over a year ago and is now at 4.3%… almost a full percentage point above its level in early 2023. Most of that increase has come over the past six months…

Cooling in labor market conditions is unmistakable. Job gains remain solid but have slowed this year. Job vacancies have fallen, and the ratio of vacancies to unemployment has returned to its pre-pandemic range…

All told, labor market conditions are now less tight than just before the pandemic in 2019 — a year when inflation ran below 2%. It seems unlikely that the labor market will be a source of elevated inflationary pressures anytime soon. We do not seek or welcome further cooling in labor market conditions…

The time has come for policy to adjust. The direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook and the balance of risks.

The Economy Is What Matters

The interest rate pivot is explicit: “The time has come for policy to adjust.” What’s less explicit but still clear is the pivot from concern about inflation to concern about unemployment. It’s a pivot from one-half of the dual mandate to the other. And the reason is critical.

Unemployment goes up during recessions and is usually a lagging indicator, meaning that the recession is already here before the rise in unemployment becomes noticeable to policymakers. The Fed won’t admit it, but that’s what just happened.

The U.S. economy is a much more powerful force than Fed interest rate changes or White House policy tweaks. It has its own dynamics that aren’t very amenable to Fed policy even if the Fed pretends otherwise.

There are ample signs that the economy is headed for a recession or may already be in one including higher unemployment, lower interest rates (low rates are not “stimulus”; they’re associated with recessions and depressions), flattening yield curves, negative swap spreads, reductions in China’s reserve positions (not a sign of “dumping” Treasuries but a sign of a dollar shortage and a need to provide liquidity to banks), declining oil prices (despite output reductions) and others.

Advantage Trump

The emerging recession (or actual recession if it is already here) will cause a stock market drawdown as earnings are revised downward, consumer confidence crumbles, consumer discretionary spending hits a wall and precautionary savings rise.

The world will not bail out the U.S. economy because China, Japan, Germany and the U.K. are all slowing economically at the same time or already in contraction.

The U.S. economy (in contrast to economists) does not pay that much attention to electoral politics. It’s too big and moves to its own complex tempo. Still, this slowdown could be a much more important electoral factor than the policy issues being shouted about.

It will clearly help Trump and hurt Kamala as Americans recall the relatively good economic conditions (pre-pandemic) during the Trump administration as described by Powell in the opening quote above.

Get ready for a very bumpy ride between now and Inauguration Day.