Economics Update June 2023 - US economy: A "soft landing" is not to be expected

There is still a lot of positive news in the round of economic data from the USA: Retail sales rose in April, the mood in the service sector is very positive, and above all, with an unemployment rate of 3.4 percent, there is still practically full employment. At the same time, however, there are some dark clouds in the economic sky: industry is suffering from an overall weak global economic environment. Higher interest rates continue to put pressure on the real estate market, and above all, the situation on the labour market is not quite as rosy as the low unemployment rate suggests. Weekly initial jobless claims have risen from less than 200,000 at year-end 2022 to around 240,000 currently, and in turn the number of job openings has fallen significantly, although it is still higher than the number of unemployed by a factor of 1.6.

The economy depends on the labour market

In fact, the labour market is crucial for the question of whether there will be the "soft landing" expected by many, with a weak growth dynamic but without a critical rise in unemployment. More likely in our view, however, is the scenario of a "real" recession, including a significant rise in unemployment. The Fed's sharp tightening of monetary policy to curb high inflation is leaving increasingly clear traces in aggregate demand. This is visible, for example, in the declining investment in equipment, which has been falling for two quarters now. If demand continues to fall, the labour market could reach a point in the foreseeable future where employees who are laid off by their company will not easily find a new job. Then people who are worried about their jobs will increase their precautionary measures and save more. This in turn would set off a cycle in which aggregate demand falls further, threatening even more layoffs.

Fed will not rush to cut interest rates

It is unlikely that the Fed will prevent this downward spiral with early rate cuts: inflation will not reach the 2% target any time soon, and economic momentum rekindled by lower interest rates could possibly push inflation up again. For the Fed, this would mean an embarrassment and an obvious failure, so Fed Chairman Powell would be well advised to avoid this risk. So the advocates of a "soft landing" should not bet on the Fed. 

As much as the agreement in the dispute over the US debt ceiling is to be welcomed, it may be precisely the associated government spending cuts that provide the decisive impetus for the scenario outlined here. The summer months should therefore be exciting for the US economy and thus for the global economy as a whole.