Weak economies, but no recession
Last week, markets were rattled by weak U.S. employment figures. These were widely interpreted as a sign that the American economy is growing much more slowly than previously thought. The same applies to Europe, where the latest data also disappointed — especially when factoring in the downward revisions to previous months’ figures, similar to the U.S.
In fact, the U.S. revisions prompted Trump to dismiss the head of the Bureau of Labor Statistics (BLS), the department responsible for compiling the data. Under normal circumstances, this might have been a justifiable action — but not now. Since the outbreak of the COVID crisis, the BLS has struggled with a sharp decline in survey response rates, and responses are now being returned much later than before. This poses a serious problem, as it means a significant share of the underlying figures must be estimated. That is risky enough on its own — though previously, at least, experts were appointed to do it. In recent years, budget cuts have weakened this process, and Musk has recently implemented even more drastic cuts. The root of the problem lies not with the BLS leadership, but with politics.
The key question now is: how should we interpret these weak figures?
Europe
In Europe, the current weakness is driven mainly by two factors:
- Trade uncertainty – Until recently, there was complete uncertainty about the future of global import tariffs and the risk of a trade war. This was hardly an environment for companies to invest and hire. While this uncertainty has eased somewhat, it has not disappeared. The agreements reached so far still need legal testing and serve more as frameworks than binding deals. Disagreements over their interpretation have already emerged. As a result, business activity will continue to face headwinds — albeit less than before.
- Export challenges to the U.S. – Regular exports to the United States are now hampered by a weaker dollar and the 15% import tariffs imposed by Washington.
The European economy is therefore contending with clear headwinds, on top of an already sluggish growth rate. However, support is on the way. Fiscal stimulus is gradually increasing, particularly through much higher defense spending. This makes the probability of a recession relatively low. As a result, there is doubt over whether the ECB will cut interest rates further. The only arguments in favor would be the slowdown in wage growth, inflation approaching 2%, and the expectation that oil prices will remain under downward pressure for the time being. This could justify one last rate cut — but that is far from certain.
United States
The situation in the U.S. is different. No major fiscal stimulus is planned. Taxes are being reduced and Washington is pushing deregulation, but these measures are being offset by import tariffs and the uncertainty they bring. The question is whether the Fed should cut rates quickly to prevent a recession now that job growth has stalled. There are at least three arguments against doing so:
- Labor market constraints – The limited increase in employment may not be due to falling demand but to a shrinking labor supply, driven by sharply reduced immigration and the deportation of foreign workers. Many economists believe this is at least partly behind the weak job figures. If so, the Fed must tread carefully when stimulating the economy, as this could quickly push wages — and thus inflation — higher.
- Total hours worked remain stable – While job creation has slowed, average hours worked per employee have not. Taken together, total hours worked have remained steady, which is what ultimately matters for economic growth.
- Inflation risks – Even if economic growth is slowing, it remains unclear whether this will be enough to bring inflation — still around 3% — down. So far, exporters and importers have largely absorbed the cost of tariffs themselves, but surveys and past experience suggest they will soon pass these costs on to consumers. This could put upward pressure on inflation in the near term. Critics argue this would be a one-off effect rather than a structural shift, but that is only true if the economy grows slowly — another reason for the Fed not to overstimulate.
Conclusion
Whereas markets currently expect at least one more rate cut from the ECB, in practice this is likely to be less rather than more. This applies even more to the Fed, where markets are pricing in significantly more cuts. Rate reductions may therefore turn out to be more limited than expected.
In our reports this weekend and next, we will examine in detail what this could mean for price movements across different markets.
