The U.S. economy has spent three years defying expectations. It emerged from the pandemic shock more quickly and more powerfully than many experts envisioned. It proved resilient in the face of both inflation and the higher interest rates the Federal Reserve used to combat it. The prospect many forecasters once considered imminent — a recession — looked increasingly like a false alarm.
Until now.
An unexpectedly weak jobs report on Friday — showing slower hiring in July, and a surprising jump in unemployment — triggered a sell-off in the stock market as investors worried that an economic downturn might be underway after all. By Monday, that decline had turned into a rout, with financial markets tumbling around the world.
Some economists said investors were overreacting to one weak but hardly disastrous report, since many indicators show the economy on fundamentally firm footing.
But they said there were also reasons to worry. Historically, increases in joblessness like the one in July — the unemployment rate rose to 4.3 percent, the highest since 2021 — have been a reliable indicator of a recession. And even without that precedent, there has been evidence that the labor market is weakening.
“Even before the employment report, you were seeing some real signs of softening in the labor market,” said Jay Bryson, chief economist for Wells Fargo.
Mr. Bryson still expects a “soft landing,” in which inflation cools without a broad economic downturn. But the chances of a more painful outcome have risen. Other forecasters said the same: Economists at Goldman Sachs over the weekend said they saw a 25 percent chance of a recession over the next year, up from 15 percent before the latest round of economic data.
More important than the predictions themselves — which, after all, have repeatedly proved unreliable — are the factors underlying them. The American economy no longer has the reserves of strength that helped carry it through the recent turbulence. Families no longer have a buffer of cash built up during the pandemic, or pent-up demand to spend it. Businesses no longer have a backlog of jobs to fill or shelves to restock.
None of that means a recession — an actual contraction of the economy — is inevitable. But it does make this economic moment more precarious than any in recent years.
Why Dour Predictions Have Been Wrong (So Far)
There is a crucial difference between the earlier, inaccurate recession forecasts and the latest set of warnings: The previous predictions were based largely on historical patterns and theoretical models. The new ones are based on actual evidence of a slowdown.
When economists began predicting a recession in 2022, inflation was high and the Federal Reserve was raising interest rates aggressively to try to bring it under control. In the past, those conditions usually led to a recession: Policymakers try to curb demand just enough to bring down inflation, but end up overshooting and causing widespread layoffs.
That didn’t happen this time. Consumers and businesses emerged from the pandemic with plenty of savings and relatively little debt, making them less sensitive to higher borrowing costs. At the same time, the easing of pandemic-related disruptions allowed inflationary pressures to dissipate without requiring a big drop in demand for goods and services.
“All of those normal rules that tend to apply in both historical experience and theoretical models were very different this time around,” said Tara Sinclair, a George Washington University professor who recently left a role in the Treasury Department.
As a result, even as many economists warned a recession was coming, there was never much evidence of one in the data. Hiring, wage growth and consumer spending all eased, but none collapsed. Unemployment remained near lows unseen in decades. Gross domestic product, the broadest measure of economic output, continued to grow at a healthy — and at times robust — pace.
Why Recession Fears Have Re-emerged
Now, though, cracks are beginning to appear. More people are falling behind on their credit card bills and car payments. Filings for unemployment benefits have begun to rise. Overall consumer spending has remained strong, but there have been signs that lower-income consumers are pulling back.
The July employment data was the clearest warning sign yet. Job growth slowed much more than expected and was concentrated in a handful of industries. The increase in the unemployment rate, the third in four months, was enough to suggest that a recession might already have begun, according to a well-known gauge known as the Sahm Rule.
Claudia Sahm, the former Fed economist who developed the rule, said disruptions during and since the pandemic might have scrambled her namesake indicator as they had so many other once-reliable recession warning signs. But she said the underlying logic — that even small increases in unemployment are something to worry about — still held.
“Given everything we know, or that we think we know, the United States is not in a recession,” Ms. Sahm said. “But the risk of going into a recession in, say, in the next three to six months? Those have really gone up.”
Reasons for Optimism
Still, by most measures the U.S. economy is slowing down, not stalling out.
Consumer spending, personal income and job growth — all measures used by the National Bureau of Economic Research to determine when recessions begin and end — have remained solidly positive. Gross domestic product, adjusted for inflation, grew faster in the second quarter than in the first, and is expected to show another gain in the third quarter. Other recent data have shown unexpectedly strong productivity growth and a rebounding service sector.
Better still, inflation has cooled significantly, which gives the Fed more leeway to reduce interest rates if the economy weakens further, without worrying as much that doing so will allow prices to start rising quickly again.
Jerome H. Powell, the Fed chair, indicated in a news conference last week — before the jobs report or the market plunge — that the central bank could cut rates as early as its next meeting in September, something investors now view as a near certainty. Some investors expect the Fed to intervene even earlier, although careful Fed watchers consider such an emergency move unlikely.
The challenge for policymakers is that after two years of seeking to slow the economy, they are aiming to do something even more delicate: Get it to level off. And they are trying to do so with imperfect and at times contradictory data, using tools ill suited to such finely calibrated adjustments.
“It’s very hard to distinguish the difference between reaching the runway and plowing through it,” Ms. Sinclair said.
Talmon Joseph Smith contributed reporting.