Typically, the first month of a recession shows the economy eliminating jobs, this clearly hasn’t happened yet. The economy added 372,000 jobs in June—far above consensus expectations of 250,000—and the unemployment rate held steady at 3.6% in May for the fourth straight month. That should dampen rampant fears that a recession is imminent, given just how many Americans are receiving paychecks and how many employers are continuing to hire.
After the housing bubble burst in 2008, it took more than six years for the economy to claw back the roughly 8 million jobs that had been obliterated. Labor market wreckage from the pandemic was even greater: Between February and April 2020, roughly 12 million jobs vanished. Two years later, almost all of them have been recovered. And if the recent pace of hiring continues, they will all be back by September.
But the labor market’s continued strength will do little to deter the Federal Reserve from staying on its aggressive monetary-policy tightening path to tame inflation—which will mean further deceleration in the broader economy and equities in the months to come and higher risks that the central bank could go too far.
“The worst mistake we could make would be to fail, it’s not an option.” said Powell
I worry about an endless cycle of crises, each caused by the "solution" to the last crisis. And with each cycle, the 'pendulum' swings a little further out than the last. In physics, this is referred to as "positive feedback."
The mathematical definition of a positive feedback loop is defined as a phenomenon where a positive gain exists within a loop of cause and effect. Positive feedback systems like these are inherently unstable systems that will usually end with some sort of divergence from the system’s normal equilibrium, possibly with chaotic runaway conditions.
The June employment report has several important implications for policymakers and investors. First, an economy generating over 300,000 jobs a month is well above its potential. Second, official rate hikes and tightening financial conditions have done little to undo the tightness in labor markets. Third, rising wages for production and non-supervisory workers have much more significant inflation implications than the high inventory levels at a few large retailers. Fourth, gains in jobs and earnings indicate employee compensation rose well above the projected gain in Nominal GDP pointing to the second consecutive quarterly decline in operating profits. And the squeeze on profits and margins will intensify as Fed lifts official rates to fight inflation.
Positive feedback loops are untenable. Because a change in an input causes responses that produce continued changes in the same direction resulting in an uncontrolled output which slams continually back and forth to the limits of its ability.
Examples of positive feedback loops
Positive feedback loop – House prices
Suppose there is a rise in demand for houses. This rise in demand leads to rising prices. Consequently, rising prices can encourage many investors to take interest in the housing market. Therefore, increasing prices encourages even more demand.
To some extent, we can see a positive feedback loop during a housing boom. If there are factors (e.g. low-interest rates, rising incomes) which lead to a rise in demand for buying a house, this will push up house prices. A sustained rise in house prices encourages more buying as investors purchase homes to gain from the ascending valuations.
We can see this kind of behavior with all bubbles. From the South Sea Bubble to the Dot Com Bubble of the 00s. It requires a particular human psychology – where individuals place a high value on prices as a sign of value.
Herding behavior or momentum trading is when people follow the wisdom of crowds. Rising prices and widespread enthusiasm results in irrational exuberance – when investors can get too excited by rising prices, forgetting that the value of an asset depends on many more factors than mere past performance.
Unstable positive feedback loops
With this kind of positive feedback loop there is growing instability – if people are incentivized to buy because of rising prices, there will come a moment when the valuation of the asset changes and people look beyond rising prices to fundamental values. This can cause some investors to sell, and the positive feedback loop starts to act in the opposite direction, with sellers causing falling price and falling prices causing more sellers. Therefore, many booms are often followed by an equally dramatic bust.
Getting inflation lower is usually painful because the Fed’s policy toolbox is geared toward cooling demand. If the Fed manages to cool demand, then there will be less price pressures, but cooling demand entails essentially making things more expensive. To put it more plainly, the idea is to reduce consumer spending and slow business expansion by increasing costs in other areas (namely, borrowing and loans). The Fed is trying to get you, for now, to stop spending.
If the Fed doesn’t increase interest rates and get inflation expectations in check, the risk is that prices will continue to spiral upward. Workers as a result will demand higher wages, companies will raise prices to pay those wages, and it becomes a vicious cycle of doom. The central bank’s task now is to stop that from happening and to try to keep high inflation from becoming entrenched. Rates have already gone up, we are already in a transition phase where the economy is slowing down. The pieces are being put in place for a rebalancing of demand and supply, but it doesn’t happen overnight. It’s usually a bumpy ride.
Will we see a recession? Recessions are self-fulfilling prophecies. If one person prepares for a recession, that’s fine, they’re going to economize, they’re going to buy a little less, they’re going to be more careful with their outlays. But if 350 million people do the same thing, if everybody cuts their spending by 5 percent, well, then there’s a 5 percent correction in spending, so that entails a recession.
I remember after prolonged quantitative easing to offset the economic stagnation of the 2009 financial crisis, in an attempt to pinpoint exactly what's wrong with the global economy — why demand is weak, why growth is anemic, why jitters on one side of the planet can turn into panic all over; Goldman Sachs CEO Lloyd Blankfein said,
“what the world needs now is confidence. In investment banking, when people are confident there are more financings, more equity raises, because people invest more money in their own businesses when they're confident."
Central banks and governments have unveiled an estimated $15 trillion of stimulus already to shield their economies from the coronavirus pandemic - record sums that have swelled balance sheets. The sum equates to about 17% of an $87 trillion global economy last year. That bought a lot of economic confidence. A little too much perhaps.
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