Weekly Economic Trends and Indicators

In the last few weeks, we have focused on the labor market—in particular how the labor market has been slowing recently while still adding jobs at close to the long run trend rate. This week, we turn our attention to the consumer. With so much discussion recently about whether this slowdown could become a recession, it is vital to consider how the strength of the consumer will impact that outcome. To tell that story, we will look back at two recessions and a soft landing.

In the years leading up to recessions that began in 2001 and 2007, The Federal Reserve embarked on a series of interest rate increases aimed at moderating the economy and preventing inflation from rising. As a result, investment in new capital began to fall first with employment growth slowing down and employment eventually contracting over the next several months. If that had been the end of the story, the recessions that followed could have been less severe or possibly could have even been avoided. In 2001, however, we were also in the midst of a stock market correction (bursting of the “dot-com bubble”) that would see the S&P 500 lose 1/3 of its value. Because of the combined effect of job losses and the perceived wealth lost in the stock market, the effect on the consumer was amplified. In 2007 and the years the followed, not only would the S&P once again lose 1/3 of its value, but housing values would take a huge hit. Once again, there was a wealth effect—even larger this time—which led to one of the most severe recessions of last 50 years.

Now consider 1994 and 1995. In 1994, the Federal Reserve also increased interest rates. The economy had picked up steam following a recession in 1990-91, and inflation was a concern. Once rates peaked in early 1995, employment growth fell off dramatically, and even contracted slightly in May 1995. At the same time investment in new capital also contracted. It looked like a recession could happen.

However, the recession did not happen. Employment growth remained rather anemic for the next year, but assets such as stocks and houses held their value quite well during this episode. Consumer sentiment also remained at levels comparable to the 1980s, considerably better than the early ‘90s. As a result, consumption spending did not fall as it would in a recession, and the recession was avoided.

In the current cycle, the Federal Reserve increased the fed funds rate to levels comparable to these past episodes and has held rates that high for over a year. Investment in new capital contracted in early 2023, again reminiscent of these examples. Now, we are seeing the expected slowdown in the labor market. The elements are there to lead to either a recession or a soft landing. Once again, it will most likely be a negative wealth effect (or lack thereof) from assets such as stocks and housing that determines whether a recession will occur or not.

So far, there has not been a shock to household wealth as there was in 2001 and 2007. Also, consumer confidence rose by about 2% this month. Thus, at least at the present time, there is still no reason to expect that a recession is imminent. Even so, the risk of recession is elevated because the economy is currently more vulnerable to an unexpected negative shock than it would be under more normal conditions. If a recession is to be avoided this time around, it will require confidence and spending to at least hold onto their current levels. It is also imperative that the Fed start to lower the policy rate to arrest the decline in job growth since that could erode consumer spending if the decline becomes too steep.

Next week: Federal Reserve interest rate decision