State of Economy August: Waiting for Harsh Reality To Kick in

In just a month, conditions in the economy are starting to worsen again (especially at the pump) as tensions in the Middle East escalate, causing higher fuel costs. But the reality about how dire the situation is hasn’t quite set in for Wall Street just yet.

Now, cracks are showing in the job market and consumer spending; at the same time, it seems that the Federal Reserve will have no choice but to hike rates to tame inflation – making life even more expensive for many.

As noted in my last economic post, I don’t take any pleasure in saying this, but conditions will likely only worsen from here.

Potential Endless War

First off, so much for the memorandum of understanding that was supposed to bring stability to the oil markets and allow safe passage through the Straight of Hormuz.

Last month, both sides traded strikes for 13 straight days – all but killing the deal. In addition, Ukraine got involved by attacking an Iranian commercial vessel and the Straight of Hormuz isn’t the only goods transporter to worry about now.

Tehran has asked its ally, the Houthis, to disrupt shipping through the Bab el-Mandeb Strait if further escalation occurs, according to Fox News.

Through the Straight of Hormuz alone, roughly a third of the global fertilizer (which impacts food prices) and up to 25 percent of the oil supply is handled through the Straight of Hormuz. That’s caused enough issues for supply chains.

Should the Bab el-Mandeb Strait face disruptions, through which about 12 percent of the global seaborne oil supply and roughly 15 percent of the world’s fertilizer pass, it could create a nightmare scenario for the economy.

Consumers Pull Back on Grocery

While we haven’t quite hit economic catastrophe yet, consumers are clearly feeling the brunt – and it’s not just at the pump.

A recent analysis from Bain & Co revealed that grocery unit sales dropped by almost 2 percent year-over-year in June. Since 2019, grocery prices have spiked by 33 percent, so it’s not just a result of the Iran war.

Bain & Co also noted that enrollments in the Supplemental Nutrition Assistance Program (SNAP) are down, as Washington cut benefits and tightened eligibility rules. This all plays a factor in pressuring lower-income households.

Employment Cracks

Another part of what appeared to be holding the economy together was the stable labor market. While hiring wasn’t booming, mass layoffs weren’t exactly happening across the U.S, with the last unemployment rate from the Bureau of Labor Statistics coming in at 4.2 percent.

However, there’s one underlying problem that stems from the report –long-term unemployment. As of June, the rate was at 27.3 percent for those who have been without a job for at least 27 weeks. This is the highest level seen since 2021, which was near the height of the pandemic, according to The Wall Street Journal.

This signals how challenging it is to find a job today. In other words, if you have a good one – it’s probably a good idea to keep it.

Rate Hike Likely Looms

The prospect of no signs of an end to the war in the Middle East, which will all but certainly continue to push oil prices up, will likely cause the Federal Reserve to raise interest rates in the short term.

Even though the central bank decided to delay the decision and wait for more data in its July meeting, it may not have another choice. The Fed has long set a goal to keep inflation around 2 percent and we are well above that with the latest Consumer Price Index data showing a 3.5 percent spike over the 12 months through June.

With the price of oil rising in recent weeks, July’s data will likely show some sort of increase. Currently, traders are giving it a 67 percent chance that the central bank will hike rates after its next meeting in September, according to CME Group’s FedWatch tool. This would put the Fed funds rate in the range of 375 and 400 basis points.

That’ll make life even more expensive for Americans, from mortgage rates to credit card debt.

Economic Reality Hasn’t Set in for Wall Street

Yet despite all of these concerns, just about everything looks dandy on Wall Street. As of this weekend, the Dow Jones remains over 52,000 points, with the S&P 500 remaining near record levels.

There is, however, some concern showing up in AI, which has caused volatility for tech stocks. The Nasdaq Composite remains down about 6% from June 2. This could be a sign that the potential AI bubble we are in is starting to pop, which is only one short-term risk.

The far bigger near-term concern is the war that’s driving up energy costs and inflation, adding pressure to consumers.

For now, reality hasn’t set in for Wall Street and the trouble that lies ahead, assuming the war does not end soon and/or if oil does not start flowing through the Straight of Hormuz again. The U.S. continues to tap through the Strategic Petroleum Reserve, which was down to the lowest level since 1983, as of July 24, according to the Energy Information Administration.

While President Donald Trump over the weekend in a Truth Social post announced that an attack on Iran has been canceled over “perimeters of a deal” being reached – keep in mind that we’ve been down this path multiple times. This could be another effort to calm the equity markets down in the near term.

However, it doesn’t change the fact that ExxonMobil Senior Vice President Neil Chapman at the Bernstein 42nd Annual Strategic Decisions Conference in New York warned that Brent oil prices could reach as high as $160 a barrel because of the shortages. That’s almost double where they are now.

So if you thought $4 per gallon gas was bad enough – just wait until it reaches $7 or $8 per gallon. That could turn into a crisis that the American economy has never seen before.

If and when reality sets in for Wall Street – we could be in for a wild ride.