Economic Resilience
Key Takeaways
- Economic Growth Remains Resilient: Strong corporate earnings and improving hiring trends suggest the U.S. economy continues to demonstrate resilience despite ongoing geopolitical uncertainty.
- Inflation and Labor Constraints May Influence Fed Policy: Persistent labor shortages and elevated energy prices may contribute to continued inflation pressures and complicate future Federal Reserve interest rate decisions.
- Markets Continue to Adapt to Global Risks: While developments in the Middle East may contribute to short-term market volatility, businesses and economies have historically shown an ability to adjust to changing conditions.
Economic Resilience Amid Geopolitical Uncertainty
Corporate profits keep coming in above expectations, with 87% of S&P 500 companies beating expectations so far for Q1 according to Barron’s, while the latest data shows more gains in hiring. Investors have demonstrated quite conclusively that they can remain focused on what matters most for their financial assets, despite the daily chaotic news coming in regarding the conflict with Iran. That’s why the market is at all time highs, appropriately so.
It is easy to look for flaws or weaknesses in the jobs report, and such comments invariably attract attention, but we saw the April numbers as showcasing the resilience of the economy. Simply, hiring is picking up again.
Labor Supply Constraints and Inflation Pressures
And this may prove to be problematical for the Fed. As was also revealed by the jobs report, the supply of labor remains on a persistent downward trajectory, losing just over 1.0 million workers over the past 12 months. This is not at all a surprise, as we have been writing about this for some time. It is a direct consequence of the change in border policies over the final 6 months of the Biden Administration and the even more restrictive policies of Trump.
There is always lots of noise and volatility in short-term data, but the underlying trend is clear; growth is continuing while labor supply is getting scarcer. Inevitably, this will become manifest in higher wage and price inflation.
Fed Policy Outlook and Interest Rate Expectations
Fed policy has been unchanged for several months, as it struggles with its conflicting objectives. Job growth was minimal for several months, suggesting to some that Fed rate reductions might be appropriate. Inconveniently, inflation has been well above the Fed’s 2% target and the Iran War boosted crude prices, so there’s little prospect for inflation moderating until oil prices come down. Don’t hold your breath.
And now job growth appears to be picking up. A better case can be made for the Fed to hike rates rather than lower them. Nonetheless, we expect the Fed’s senior people to remain divided and leave policy unchanged, even with Warsh joining the Fed as Chairman.
Market Volatility and the Impact of the Iran Conflict
As we’ve seen repeatedly, incoming news out of the Middle East triggers sharp advances and retrenchments. As long as the hardliners remain in control in Tehran, it is hard to envision a satisfactory agreement to the conflict. More likely, additional fighting may occur to break the impasse.
But the domestic economy manages to keep rolling along and there’s little reason to expect the Iran situation to derail growth. A real agreement that settles the war with Iran is surely inevitable, since the war can’t continue forever, and it would doubtless unleash the market to the upside, but we see no reason to anticipate such a development over the near future.
Why the U.S. Economy Continues to Show Resilience
In the meantime, we see recent trends continuing, which isn’t a bad outcome. Business is highly adaptable, so expect efforts far and wide to make do with reduced supplies of crude oil, even if there are some adverse consequences, such as higher inflation over the near term. But people are creative, so workarounds will be used to adapt.
It is not only the U.S. economy that is resilient, others are, too. Our highly market based economic system is somewhat more adaptable and resilient than others, but even they will adjust.