The outlook for the U.S. economy has darkened.
Just as it seemed as though the global economy and its tangled supply chains could be getting back to normal, three factors might supercharge inflation and/or raise the risk of recession.
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The first of the three developed in just the past few days: a new covid wave in China that has already led to major lockdowns and will further stress the world’s struggling supply chains. If you haven’t heard much about this yet, you probably will soon.
Daily covid cases in China have reached numbers not publicly reported since 2020. Thanks partly to low vaccination rates for the elderly in China, plus the relative ineffectiveness of Chinese-made coronavirus vaccines, the Chinese government has responded to outbreaks with an iron fist. Under its so-called “zero covid” policy, several areas have been locked down in recent days, with nonessential workers mostly barred from leaving their homes in the major manufacturing hubs of Shenzhen (a city of 17.5 million people) and Changchun (9 million).
Transportation to Shanghai, the country’s largest city (25 million), has been severely restricted, raising fears of a possible lockdown there, too.
These measures have forced factories, including plants affiliated with Apple, Toyota and Volkswagen, to suspend operations. The backlog of container ships waiting off Qingdao, one of the country’s biggest ports, has also swelled, with nearly twice as many ships queued up Monday as at the end of February. These bottlenecks are expected to drive container freight prices (even) higher.
All of this will be bad for already elevated inflation, in both the United States and the rest of the world. The only possible economic upside is that factory shutdowns will likely reduce global demand for oil.
This might be helpful in light of Shock No. 2: the disruptions in commodity markets, including oil, resulting from Russia’s unprovoked invasion of Ukraine.
This issue has obviously generated more coverage. Oil and natural gas prices have climbed in recent weeks as governments and individual corporations have placed new restrictions on transactions with Russia. Oil prices have fallen back a little in the past few days but remain high.
Equally worrisome are rising prices for other commodities produced in that part of the world. Russia and Ukraine together supply nearly a third of global wheat exports, with the Ukraine planting season usually occurring in mid-March (i.e., now). Even before the war, global stocks of wheat were low, and prices high, thanks to unfavorable growing weather over the past two years. In the wake of Russia’s invasion, wheat prices have skyrocketed, threatening to boost food inflation more broadly. The risk of widespread hunger and economic hardship is especially high in lower-income countries that are most reliant on Europe’s breadbasket.
Finally, there’s the third risk: tightening financial conditions, thanks to the Federal Reserve.
The Fed is widely expected to raise interest rates at its meeting this week. Given that U.S. inflation is already at a 40-year high, this is hardly surprising. In a different era, few would have predicted that interest rates could be at zero when inflation hit nearly 8 percent (as happened in February). With hindsight, even Fed officials would probably agree that they should have begun tightening months ago.
Fed officials had delayed taking these measures earlier because they feared doing so would derail the post-pandemic recovery. Most previous Fed efforts to tamp down inflation by making it harder to borrow ended with the Fed plunging the U.S. economy into recession, after all.
Central bankers have been hoping to avoid that outcome this time, particularly because there are still 2 million fewer jobs today than existed before the pandemic. And for a long time, most economic forecasters believed inflationary pressures would largely abate on their own as supply chains normalized. That clearly hasn’t happened.
Engineering a “soft landing” for this hot economy was always going to be difficult. But it got more difficult in light of recent global events, because the Fed is being pulled in conflicting directions. Chinese supply chain problems and Russia/Ukraine commodity market disruptions are widely expected to push overall inflation even higher, which would normally nudge the Fed to raise interest rates faster. But those same forces are also expected to drag down economic growth, which usually suggests the Fed should raise rates more slowly.
It’s not obvious what path the Fed should or even could take to get inflation under control without tipping us into recession. Frankly, even without aggressive rate hikes, recession risks are piling up.
There’s never a good time for a downturn. But given all the other suffering and loss of life over the past few years, it’s hard to imagine a worse time than the present.
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