Investors are worried that the U.S. economy could fly right over a “soft landing” and end up in a recession, based on recent signs of sluggishness. In particular, they are concerned that languishing employment could significantly drag down consumer spending, which has helped propel economic growth amid weakness in manufacturing and housing, and strained finances among lower-income households.
In the second quarter of 2024, which ended on June 30, the U.S. added 177,000 jobs per month, on average, versus the previous 3-month moving average of 214,000 jobs. The unemployment rate has increased to 4.1%, just a notch above the level believed to be consistent with full employment. Concurrently, we see consumer spending decreasing to 1.8% for 2024 compared with 2.7% in 2023.
While the current sputters may have raised alarm bells, Morgan Stanley Research views the recent slowing as orderly and supportive of the case for a soft landing. We continue to believe the Federal Reserve will start rolling back interest rates in September, with two subsequent rate cuts to follow before the end of the year.
However, data will continue telling the story until then. We will be watching three things to see if the narrative shifts toward a recession: labor, consumer spending and the Federal Reserve.
Gauging Labor
The 3-month moving average unemployment rate is a closely watched investor indicator that in the past has helped signal the start of a recession, and it has come very close to reaching an important threshold: It is currently about 40 basis points higher than the 12-month low, or about 10 basis points shy of a 50 basis point trigger. However, our preferred measure—which considers changes in the employment-to-population ratio—is in a more comfortable range. Additionally, jobless claims and layoffs have remained low, and while the pace of job growth slowed last quarter, the 6-month moving average shows a more robust picture supporting our call for a soft landing. Still, a further decline in the employment-to-population gauge over the next quarter could point to a recession.
Tracking Consumer Spending
On the consumption side, investors are finding classic recessionary clues in decreased household spending on gasoline and a slowdown in vehicle miles traveled, which generally tracks with GDP growth. Goods and services consumption slowed to an estimated 1.4% in the first half of this year from a 3.2% annual rate in the first half of 2023. But while the pace of the recent consumption slowdown reflects below-potential growth, we think it has been exaggerated by the difference in rising prices and falling retail sales during the first half as inflation continued to affect Americans’ wallets. We believe the slowdown in spending on goods indicates a normalizing economy, and discretionary spending excluding clothing, food, energy and housing has stayed buoyant. That said, further slowing in services consumption after the decline of the past two months would be worrisome.
Watching Fed Moves
Investors fearing a potential recession are also pondering how the Fed would respond in the event of a downturn. In 2001 and in 2007, before the Global Financial Crisis, the central bank opted for 50-basis point cuts when the data started flashing red. With two jobs reports due before the September meeting, the labor market will continue to be a critical indicator of the potential scope of the Fed’s response. The Fed might also be pushed to bolder action if GDP and core prices excluding food and energy, the Fed’s preferred inflation gauge, are significantly askew from its June projections.
We think the data point to an economy on its way to a soft landing, and absent a big economic shock, reiterate our view for a 25-basis point cut in September, followed by 25- basis point cuts at each meeting through the middle of next year.
