The US just released another negative GDP for 2Q 2022. Now, we have 2 consecutive quarters of economic contractions. And all this while inflation is still sky high. The last CPI number for June hit a record 9.1%. It would seem that we now have high inflation in the midst of an economic decline.
So, does that mean we are in stagflation right now? And isn’t that the very fear that rattles the market at the start of the year? But if the fear turns into reality, then why isn’t the market tumbling? In fact, the market looks more like it is celebrating.
Economic Contraction Does Not Equate to Recession
An economic contraction is just one of the criteria for a recession. To fulfill this criterion, economists look for two or more consecutive quarters of decline which was delivered. But if that is all there is to it at this juncture, then this looks nothing like a recession yet.
A key ingredient, the labor market, is still holding up. Even though some companies are cutting headcounts, the overall job numbers and wage growth remained strong. The US Nonfarm Payrolls are still well above 300K and beating consensus estimates for the past few months. And the yearly wages are also growing in excess of 10%, well above pre-Covid levels.
Unsurprisingly, the unemployment rate reinforces the same picture. It has recovered back to its pre-Covid historical low of 3.6%.
Labor participation is, however, still below the pre-Covid levels. This ties in with the present story. A shortage of labor exacerbates supply issues and drives wages higher contributing in part to inflation. But at least for now, it is generally trending up, albeit slowly, in the post-pandemic recovery.
Job vacancies pushed to new highs. The sharp jump is a reflection of the continued strong demand for manpower following the pandemic as well as a concurrent shortage of labor.
So no, this is definitely not the stagflation scenario most people envisaged. The market is always forward-looking and adjusting as new information comes. Economic numbers, meanwhile, are lagging indicators. Even before we had a second negative quarterly GDP reading, the S&P 500 already entered the technical bear territory a month ago. It has recovered a fair bit since then. I believed what the market is adjusting to now is a more positive narrative where demand and a strong job market will buffer the negative impact coming from Fed’s aggressive rate push to tackle inflation. And as inflation abates and supply chain issues resolve, the Fed will stop hammering everyone. If the situation warrants, the Fed will also have a bit more room to maneuver and support the market then.
But will this be what really unfolds? Your guess is as good as mine. Well, we will see in due time.
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