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No matter how long inflation lasts and how high interest rates go, it seems the economy simply refuses to play its usual role in this edition of what’s supposed to be the recession narrative.
You know how it’s supposed to go. Inflation comes barreling out of the gate. The Federal Reserve takes a moment or two (or three, in this case) to assess whether price pressures are transitory or persistent. Once they decide it’s the latter, the Fed starts pushing rates upward. At some point, the cost of money ultimately gets so high that the economy starts to break. Next, consumers stop spending, stores and manufacturers have less business, and workers get laid off. Last stop: recession.
Since 1961, the central bank has embarked on a formal rate-tightening regime nine previous times to bring inflation under control. Eight of those times, a scenario that’s broadly similar to the one outlined above has unfolded.[1]
The odds, then, of the Fed achieving a genuine “soft landing” from both elevated inflation and the higher interest rates deployed to rein it in seem quite poor. Yet fierce resistance by the economy this time around against tipping into recession raises the possibility that this could be another rare moment in history: one at which recession is avoided despite what has been an economic cycle characterized by both the highest inflation and fastest interest-rate increases in the last 40 years.[2]
After all, despite the large helpings of inflation over the last 2½ years and higher interest rates over the last 1½ years, unemployment remains near a five-decade low; consumer spending has stayed steady; and real GDP growth has been growing over the course of 2023.[3] Oh, and there’s this: the inflation that was north of 9% a little over a year ago has decelerated steadily since, and is now at just over 3%.[4]
The economy’s demonstrated resilience apparently has made believers of many in the analyst community. Recently, analysts from a number of investment banks, including Goldman Sachs, BMO Capital Markets and J.P. Morgan, have “amended” earlier projections to say they no longer expect the U.S. economy to topple into recession.[5]
Even the Federal Reserve, which just a few months ago said recession was going to be in our midst later this year, has since officially backed away from that forecast.[6]
But as it turns out, not everyone agrees…including some at the same Federal Reserve that just said inflation is, in their estimation, off the table.
The New York Fed says there’s still a 66% chance of recession by next July.[7] And they’re by no means the only ones projecting a downturn. A variety of strategists have been making the rounds on popular financial media outlets recently to underscore their opinion that any assumptions the recession essentially has been “canceled” are misguided.
This week, we’re going to review what some of those strategists have been saying. The fact is, there are many intelligent, insightful observers of the economy who refuse to embrace the now-prevailing narrative that a soft landing is how the current high-inflation/higher-interest-rate cycle finally comes to an end.
Let’s find out why.
Analysts who believe a recession remains in the cards think those who do not may be getting fooled by the fact it has yet to arrive, despite all the antagonism of the economy by chronic inflation and tighter rates.
“The recession has been delayed; it’s not been derailed,” crowed economist David Rosenberg just a handful of days ago on Bloomberg Television.
“Normally it takes two years, actually, after the first rate hike by the Fed and the start of the recession,” Rosenberg explained, adding, “We’re not getting out of this without a recession.”[8]
Rosenberg sees signs of trouble brewing in the consumer-credit markets as an especially revealing canary in the recession coalmine.
“You’re going to have a huge default cycle,” Rosenberg said. “You’re already starting to see it in auto loans. You’re seeing it in credit cards. You will see it across the gamut.”[9]
Rosenberg went as far as to effectively accuse the CEOs of banks that reversed earlier recession forecasts of being disingenuous. Why? He says they’re putting on their “happy faces” about the economy for the public even as they take steps to protect their institutions from the impact of prospective widespread defaults.
“What have the banks been doing?” Rosenberg asked rhetorically. “The banks have been raising their loan-loss provisioning. They know what’s coming down the pike.”[10]
Piper Sandler’s chief global economist Nancy Lazar is another who suspects those throwing in the towel on recession may be doing so prematurely.
During an appearance last week on CNBC, Lazar suggested that “because the economy hasn’t hit a wall yet, there’s a general perception therefore it won’t slow.” Like Rosenberg, Lazar believes there’s a time lag still unfolding between rate increases and their actual impact on the economy.[11]
However, Lazar remains adamant in her contention that a recession is still on the way.
“They will further slow economic activity,” the economist said, referring to rate hikes. “We have already seen a slowdown in the economy. Why has the PMI (purchasing managers’ index) dropped clearly below 50? Why have employment gains slowed? Because the lag effect of the Fed tightening cycle is starting to creep into the economy.”
Lazar said that she and her team think the “bullseye” of recession onset will be the fourth quarter of this year.[12]
Citi economist Veronica Clark recently told “Bloomberg Surveillance” host Tom Keene that she’s not buying into the soft-landing narrative because there’s no way, in her view, that inflation “durably, sustainably” gets back to 2% unless there’s additional “loosening” in the labor market – a nice way of saying “higher unemployment.”[13] The implication of Clark’s analysis is that the only way inflation is corralled once and for all (for this cycle, anyway) is by a continued tightening in monetary policy to a point that it “breaks” the job market.
Jeff Klingelhofer, managing director at Thornburg Investment Management, recently told CNBC’s Melissa Lee said that he and his team “still expect a recession in either the late part of this year or more likely the early part of 2024.” Klingelhofer, like David Rosenberg, underscored that one variable of particular interest to him right now is the matter of rising delinquencies in the realm of consumer debt.
“The consumer has been incredibly, incredibly strong,” Klingelhofer acknowledged. “But one thing we’re watching in particular is that ‘roll rate’ from 30 days delinquent to 60 days delinquent.”
“We’re seeing all the signs that point to recession,” he added. “They’re just playing out over a much longer timeframe than we expected.”[14]
In a subsequent appearance on “Bloomberg Daybreak: Australia” just a few days ago, Klingelhofer again emphasized his view that “the recession is delayed; it’s not canceled.”[15]
It’s clear the “recession delayed, not canceled” message is the central, recurring theme of those who believe a downturn continues to lie in wait. As for what, exactly, is holding it up, “pro-recession” analysts such as those referenced here seem to think much of the delay is attributable fundamentally to the idea that the effects of rate hikes simply have yet to catch up with the economy. We’re going to talk a little more about that, but we’re also going to discuss another possible reason why a recession-free economy has persisted thus far – and why it may be on borrowed time.
Is it possible that the reason we’ve yet to see recession is that the spate of rate hikes initiated since March 2022 – 11 of them, to be exact – simply haven’t finished working their way through the economy?[16]
There may be something to that, even if one thinks the lag time between a change in interest rates and the impact of that change on the economy is closer to 12 months than what has been the historically accepted standard period of 18 months to two years.[17] A lag time of one year suggests we wouldn’t as yet have felt the impact of a fed funds rate above 3%, which is where it landed after the Federal Open Market Committee raised rates 75 basis points last September.[18]
Perhaps it’s still a little too soon to conclude that all the rate hikes we’ve seen up to this point have bounced off the economy not unlike the way bullets bounce off Superman. The truth may be – as David Rosenberg and Nancy Lazar say, for example – that those bullets are still on their way to the target.
But others have suggested still another reason why a recession has not come to pass…and why it may be too soon to decide that one has been avoided entirely: the willingness of consumers to dig into savings – as well as go deeply into debt – so they can continue spending through the economic challenges of the last two-plus years.[19] Recent data suggests Americans may be close to exhausting the extra cash and credit on which they’ve been relying heavily to help keep the nation’s economic engine churning.
At its peak, the amount of excess savings accumulated by Americans during the pandemic reached $2.1 trillion. Now, according to a report by researchers at the San Francisco Federal Reserve, those cash cushions are projected to be depleted some time during the third quarter of this year.[20]
Signs of possible distress in the realm of consumer-credit access are starting to become evident, as well. In the second quarter, credit-card debt officially climbed above $1 trillion for the first time in history…and it seems delinquencies now are rising, as well. Through the second quarter, credit-card delinquencies reached an 11-year high (using a four-quarter average).[21] And according to a recent report by MarketWatch, the delinquency rate of credit-card debt at small and medium-sized banks reached an all-time high this year.[22]
To be clear, I’m not suggesting any of this is “validation” of the posture assumed by those economists and analysts referenced earlier that recession is, in fact, still on the way and its arrival is merely a matter of time. Currently, it’s not possible to know whether a recession is or is not a fact of our future.
And that’s actually the point. The uncertainty that has come to largely characterize the economic landscape remains in effect; the fact that that highly credible economists, analysts and strategists can look at the same set of available data and arrive at different conclusions about what lies ahead is perhaps among the very best examples of that uncertainty. And one of the very best examples, as well, of why retirement savers should prepare to weather whatever economic environment comes next.
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