Markets think it's the end of the recovery as we know it, but the US economy feels fine.

Better than fine, actually. After all, it just added a blockbuster 312,000 jobs in December, turns out to have added 58,000 more jobs than we had previously thought in the months before, and, thanks to six straight months of unemployment below 4 per cent, is now seeing workers get their biggest raises, albeit not adjusted for inflation, since the recovery began almost 10 years ago.

All of which is to say that the Federal Reserve is in a fairly awkward spot right now. How is that?


Well, all of the backward-looking economic data says that we're nowhere near a recession - not when we've added an average of 254,000 jobs a month in the past three months, compared with the 100,000 or so we'd need to keep the unemployment rate from going up - while most of the forward-looking financial indicators say that one might not be that far away.

In other words, for every bit of good news about today, such as the continued growth in manufacturing employment, there's a bit of bad news about the outlook for tomorrow, such as the big drop in manufacturing production.

Which is why the Fed is justified in thinking that it'll need to raise rates a few times this year to keep inflation in check at the same time that markets are, maybe not equally justified, but still on firm ground in thinking that it's more likely that the Fed will end up cutting them.

So what should the Fed do then? Well, in this case, the easy answer is the correct one. It should wait.

Federal Reserve chairman Jerome Powell. Photo / AP
Federal Reserve chairman Jerome Powell. Photo / AP

That's because we don't know how much of today's growth will go away tomorrow once the stimulative effect of Trump's tax cuts fades away.

Or how much of the slowdown in the rest of the world will put a speed limit on our own economy. Or whether higher wages will continue to suck more people into the workforce, as they did last month, or are instead a sign that companies are starting to run out of workers.

The good news, then, is that - as Federal Reserve board chairman Jerome Powell took pains to emphasize on Friday - this is exactly what they intend to do.

If things do indeed get bumpy over the next few months, the Fed is perfectly willing to put its rate-hiking plans on hold, and even stop its bond holdings from shrinking any further.


Which are real possibilities.

See, while it's easy to make fun of the stock market for, as the old saying goes, predicting nine out of the last five recessions, it's important to understand that part of the reason it has so many false positives is that it often prompts policymakers to act before things get worse.

So both we and the Fed should take it seriously, especially when the much less erratic bond market is telling the same story.

Indeed, the fact that long-term interest rates are very close to being lower than short-term interest rates is its way of saying that it thinks the Fed is going to have start cutting rates soon - which it would only do to fight a recession.

And that brings us to the most important point of all: What makes a warning a warning is that it happens before things get bad.

Markets are on firm ground in thinking that it's more likely that the Fed will end up cutting rates. Photo / AP
Markets are on firm ground in thinking that it's more likely that the Fed will end up cutting rates. Photo / AP

So yes, the economy is in very good shape right now, but so was it in 2006, the last time long-term rate fell below short-term ones.

That didn't keep the economic storm clouds away 12 to 18 months later - that's usually how long it takes for a recession to hit after the yield curve "inverts" like that - and it won't this time either if we aren't careful.

It doesn't have to be that way, though. There's nothing inevitable about recessions. Australia hasn't had one since 1991, and we don't have to have one in 2020, as markets seem to think we will, if we make the right choices.

Matt O'Brien is a Washington Post reporter covering economic affairs