Rising interest rates were widely expected to put the U.S. economy in reverse. Now things are looking rosier, but don’t pop the Champagne corks yet.
The recession was supposed to have begun by now.
Last year, as policymakers relentlessly raised interest rates to combat the fastest inflation in decades, forecasters began talking as though a recession — economic contraction rather than growth — was not a question of “if” but “when.” Possibly in 2022. Probably in the first half of 2023. Surely by the end of the year. As recently as December, less than a quarter of economists expected the United States to avoid a recession, a survey found.
But the year is more than half over, and the recession is nowhere to be found. Not, certainly, in the job market, as the unemployment rate, at 3.6 percent, is hovering near a five-decade low. Not in consumer spending, which continues to grow, nor in corporate profits, which remain robust. Not even in the housing market, the industry that is usually most sensitive to rising interest rates, which has shown signs of stabilizing after slumping last year.
At the same time, inflation has slowed significantly, and looks set to keep cooling — offering hope that interest-rate increases are nearing an end. All of which is leading economists, after a year spent being surprised by the resilience of the recovery, to wonder whether a recession is coming at all.
“The chances of a soft landing are higher — there’s no question about that,” said Diane Swonk, chief economist at KPMG US, referring to the possibility of bringing down inflation without causing an economic downturn. “I’m more optimistic than I was six months ago: That’s the good news.”
The public is feeling sunnier too, though hardly ebullient. Measures of consumer confidence have picked up recently, although surveys show that most Americans still expect a recession, or believe the country is already in one.
There is still plenty that could go wrong, which Ms. Swonk noted. Inflation could, once again, prove more stubborn than expected, leading the Federal Reserve to press on with interest rate increases to curb it. Or, on the flip side, the steps the Fed has already taken could hit with a delay, sharply cooling the economy in a way that has not surfaced yet. And even a slowdown short of a recession could be painful, leading to layoffs that are likely to disproportionately hit Black and Hispanic workers.
“Soft is in the eye of the beholder,” said Nick Bunker, director of North American economic research at the career site Indeed.
Economists are wary of declaring victory prematurely — burned, perhaps, by past episodes in which they have done just that. In early 2008, for example, a string of positive economic data led some forecasters to conclude that the United States had managed to navigate the subprime mortgage crisis without falling into a recession; researchers later concluded that one had already begun.
But for now, at least, talk of worst-case scenarios — runaway inflation that the Fed struggles to tame, or “stagflation” in which prices and unemployment rise in tandem — has been ceding the conversation to cautious optimism.
“We have seen a huge string of shocks, so I can’t predict what the future will hold,” Lael Brainard, a top White House economic adviser, said in an interview last week. “But so far, the data is very much consistent with moderating inflation and a still-resilient job market.”
Inflation has come down.
Economists have become more optimistic for two main reasons.
The first is inflation itself, which has cooled rapidly in recent months. The Consumer Price Index in June was up just 3 percent from a year earlier, compared with a peak of 9 percent last summer. That is partly a result of factors that are unlikely to repeat — no one expects oil prices to keep falling at a rate of 30 percent per year, for example.
But measures of underlying inflation have also shown significant progress. And consumers and businesses appear to expect price increases to return to normal over the next few years, which makes it less likely that inflation will become embedded in the economy.
Cooling inflation could allow the Fed to continue to slow its campaign of interest rate increases, or perhaps even to stop raising rates altogether earlier than planned. That could reduce the chances that policymakers go too far in their effort to control inflation and wind up causing a recession by mistake.
“Things have been going in the direction you would need them to go in order for you to get a soft landing,” said Louise Sheiner, a former Fed economist who is now at the Brookings Institution. “It doesn’t mean you’re guaranteed to get it, but certainly it’s more likely than if inflation was still 7 percent.”
The job market has been resilient.
The second reason for optimism has been the gradual cooling of the labor market from a rolling boil to a strong simmer.
The rapid reopening of the economy in 2021 led to a huge imbalance between supply and demand: Restaurants, hotels, airlines and other businesses suddenly had hundreds of thousand of jobs to fill, and not enough people to fill them. For workers, it was a rare moment of leverage, resulting in the fastest wage growth in decades. But economists worried that those rapid gains could make it hard to get inflation under control.
In recent months, however, the frenzy has subsided. Employers are not posting as many job openings. Employees are not hopping from job to job as freely in search of higher pay. At the same time, millions of workers have joined or rejoined the work force, helping to ease the labor shortage.
So far, however, that easing has happened without a significant increase in unemployment. The jobless rate is roughly where it was in the strong labor market that preceded the pandemic. Some industries, such as tech and finance, have laid off employees, but most of those workers have found other jobs relatively quickly.
“Labor market overheating is diminishing substantially, to levels where it’s no longer so worrisome,” said Jan Hatzius, chief economist for Goldman Sachs.
Mr. Hatzius, who has long been more optimistic about the prospects for a soft landing than many of his peers on Wall Street, on Monday lowered his estimated probability of a recession to 20 percent from 25 percent. He said the recent progress in inflation and the labor market — as well as in consumer spending and other areas — suggests the economy is gradually moving past the disruptions of the past few years.
“We’re seeing the other side of the pandemic,” he said. “The pandemic created all of this enormous turbulence in economies, and now I think it’s going away, and to me that’s the overriding theme.”
Still, many economists are less sanguine. Inflation, at least excluding volatile food and energy prices, remains well above the Fed’s 2 percent annual target, at 4.8 percent in June. And although the progress on inflation so far may have been relatively painless, there is no guarantee that will continue — employers that initially responded to higher interest rates by hiring fewer workers may soon begin cutting jobs outright.
“People taking victory laps declaring a soft landing I think are premature,” said Laurence M. Ball, a Johns Hopkins economist who last year wrote an influential paper concluding that it would be difficult for the Fed to get inflation back to 2 percent without a significant increase in unemployment.
Part of the problem is that the Fed has little margin for error. Act too aggressively to tame inflation, and the central bank could push the economy into a recession. Do too little, and inflation could pick back up — forcing policymakers to clamp back down.
Neil Dutta, head of economic research at Renaissance Macro, says he worries the strong labor market will fuel a new acceleration in the economy, leading to a resumption of rapid price increases — an “inflationary boom” that reverses much of the recent progress.
“The next three to six months, the inflation dynamics will look pretty good — it will feel like a soft landing,” he added. “The question is, what comes after?”
Then there are the factors outside of policymakers’ control. Oil prices, which soared last year when Russia invaded Ukraine, could do so again. Food prices could start rising again, too — a possibility that became more real this week when Russia canceled a deal to allow Ukraine to export grain on the Black Sea.
With the economy already slowing, even relatively small developments — such as the looming resumption of student loan payments, which will strain the finances of many younger adults in particular — could be enough to knock the recovery off course, said Jay Bryson, chief economist for Wells Fargo.
“The student loan thing is not, in and of itself, enough to cause a recession, but if you do have a downturn, it could be a kind of death by a thousand paper cuts,” he said.
Mr. Bryson still expects a recession to start this year. But he has become less certain in recent months. He recently asked the nearly 20 people on his team to write down how likely they thought a recession was in the next year. Answers ranged from 30 percent to 65 percent, with an average of exactly 50 percent — coin-flip odds for a soft landing that many people once thought impossible.
“Keep the Champagne on ice,” Mr. Bryson said. “Hopefully early next year we can start popping it.”