Macroeconomic & Geopolitical

Recession is Coming, But Will You Know When it’s Here?

March 2023 – 3 min read

The risks have risen, but it may arrive later than expected and you may not even notice until it’s over.

At one level it's not a hard question. We have had the fastest pace of rate hikes in four decades, a gut-wrenching market selloff, and an inverted yield curve that makes borrowing short more expensive than lending long. If you add in the medium-sized banking crisis, it doesn’t take a genius to predict a U.S. recession.

And yet if there were ever an economy that could weather this storm, it's one where so many bosses still desperately need workers, so many families sit on ample excess savings, and where so few companies have trouble refinancing their debt. All of this may change if we are surprised by more bank failures or another supply shock that delivers a further surge in prices. But with the end of the tightening cycle coming into view, the next recession doesn't look like much of a recession so far.

Before getting too excited, we should still brace for another potential couple of rate hikes as the dust settles on the recent market turmoil. Wages and prices are headed lower, but the trajectory is still not entirely convincing. Even with the most recent Personal Consumption Expenditures index coming in at 5.0% above last year, the Federal Reserve (Fed) will want to make sure that inflation is marching decisively lower before it starts letting up on the brake.  That may not come until next year.

The economy is clearly slowing as higher interest rates take hold and credit tightens. Unemployment will surely edge higher. The question for investors is whether we are headed for a mild downturn, which markets now seem to expect, or something much more serious.

The most common definition of a recession is simply two quarters of negative growth. For what it's worth, current consensus among economists is that the U.S. economy will grow in the second quarter by 1.5% compared to a year ago, decelerate to half that rate in the third quarter, and deliver something barely positive through the coming winter. The average forecast starts to pick up again sometime next spring.

But as late as last fall, the U.S. economy was forecast to hit bottom during the first quarter of this year, but instead it is now likely to deliver annual growth above 1.5%. Don’t be surprised if the current predications calling the bottom are further delayed.

A more sophisticated reading comes from the National Bureau of Economic Research (NBER), the think tank that has been measuring and dating business cycles since 1929 (which, as you may recall, was quite a cycle). It defines recession as "a significant decline in economic activity that is spread across the economy and that lasts more than a few months." Its committee alliteratively considers the "depth, diffusion and duration" of the downturn.

While the NBER reviews a range of measures, it directs attention to six datasets in particular: real personal income, nonfarm payroll employment, real personal consumption expenditures, real wholesale-retail, employment as measured by the household survey, and industrial production. If you examine these charts today, the lines point mostly upward and to the right suggesting an economy that’s still full of momentum in spite of everything.

But as even the NBER’s Business Cycle Dating Committee agrees, these data are backward-looking and subject to meaningful revisions. Unemployment numbers, in particular, can fall even as a downturn is taking shape, and may continue to rise long after a robust recovery takes hold. Personal consumption expenditures make up a large part of gross domestic product, but historically reflect only a small part of the economic contraction during actual recessions.

If predicting future growth rates looks fraught, however, we can still take comfort in the economy’s resilience to current stress. We are now well into this painful rate hike cycle and the U.S. Composite Purchasing Manager Index is now on the rise after several months of contraction. There are more job openings recorded today than six months ago and consumer sentiment is higher.

The headwinds from the collapse of prominent regional banks present a real challenge if a broad credit squeeze ensues. But so far, at least, weekly growth rates in bank lending have bounced back since the failure of Silicon Valley Bank. The Fed’s commitment to finance deposit withdrawals against collateral at par will go a long way to cushion the blow.

If the laws of gravity and economics require that all periods of expansion be interspersed with at least some brief intervals of contraction, then it’s clear that a recession is due. But the current momentum in economic activity and the Fed’s readiness to contain further banking turbulence offer comfort that it may not be so bad when it comes.

Indeed, the NBER itself admits its own recession designations lag by four to 21 months. Which begs the question: If a recession comes and there’s no one there to measure it, will it make a sound?


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