More and more economists are dropping their recession calls for the U.S. economy. They are forecasting instead a “soft landing” in which the economy continues to grow, but more slowly. A headline in The Times on Wednesday asked, “Could the Recession in the Distance Be Just a Mirage?” My Opinion colleague Paul Krugman wrote on July 13 that “a happy outcome that not long ago seemed like wishful thinking now looks more likely than not.”
I understand the case for optimism. Unemployment is still low. Inflation has come down, lessening the need for the Federal Reserve to cool the economy off with higher interest rates. Consumer confidence has strengthened. And the stock market is up, which makes people feel wealthier and in the mood to spend. Plus, stock investors try to be alert to danger, so it means something when they keep buying.
The economist Mark Zandi, in a CNN op-ed last month, gave five additional reasons he thinks the economy will escape a recession: Consumers still have some unspent savings from the pandemic stimulus; businesses will be slow to lay off workers even if conditions worsen, because talent is hard to find; household and business debt loads are light; inflation expectations are low and well-anchored, so the Fed can relax; and oil prices have receded.
All that said, I’m sticking with my prediction of a recession. If the economy doesn’t crack this year, I still think a downturn is highly likely next year (which would be bad timing for President Biden and better for whichever Republican opposes him in the 2024 election).
Right or wrong, I’ve been hammering on recession for a long time. In December, I wrote, “A Strong Signal That Recession Is Looming.” In March, I wrote, “Will the Fed Cause a Recession?” In April, I wrote, “Why We’re Probably Headed for a Recession.”
As readers of this newsletter know, I’m not an economist of any kind, let alone a forecaster of the macroeconomy. But that’s OK, because it’s not me I’m asking you to heed. All I want you to look at is what I’m looking at, which are data points that have been highly reliable indicators of recession for many years. Sure, they could be wrong. But “this time is different” is generally not a good way to bet.
One persuasive data point is the steady decline in the Conference Board’s Leading Economic Index. The index tends to rise and fall ahead of the overall economy. In June, it fell for the 15th straight month, which was the longest streak of consecutive decreases since 2007-08, when the economy was tumbling into a deep recession.
Looking at every recession since December 1969, the economist David Rosenberg has calculated that, on average, the Leading Economic Index starts to decline 13 months before a recession begins and falls 4.6 percent before the recession begins. By that metric, we’re even deeper into the danger zone than we were ahead of past recessions: June marked 18 months since the index’s peak, and the decline from the peak has been 9.9 percent.
This leading index is called “leading” for a reason. “Fifteen Strikes in a Row on the L.E.I. and the Economy is Out (Every Time)!” read a chart headline in a client note from Rosenberg, the founder and president of Rosenberg Research in Toronto, on Friday.
One of the components that’s dragging down the leading index is worth examining separately. It’s the shape of the yield curve. On a chart, the yield curve slopes upward from bottom left to top right when short-term interest rates are lower than long-term interest rates. That’s usually a sign of a healthy economy. When the yield curve “inverts” — sloping downward from top left to bottom right — it’s a strong recession indicator. One possible explanation is that an inversion reflects an aggressive Fed (the high short-term rates) coupled with gloomy expectations that the economy will slow and the Fed will need to change course (the low long-term rates).
And boy, has the curve inverted! When I wrote in December that the yield curve was flashing red, 10-year Treasury-note yields were about 0.8 percentage points lower than 3-month Treasury bill yields. Now, after several more Fed rate hikes, the gap has nearly doubled to almost 1.6 percentage points. According to data from FactSet, the inversion this year is the biggest in its records, which go back to 1982.
The Fed’s rate-hiking campaign has lifted the federal funds rate target range by 5 percentage points since March 2022. In the past, smaller increases than that, spread out over longer periods, have been enough to send the economy into recession.
I realize some smart economists and strategists are saying that these indicators have lost their predictive value. “The situation we are in is very different from normal,” Bryce Doty, a senior portfolio manager at Sit Investment Associates, told The Times this month. He said he doesn’t think the yield curve’s inversion signals recession. Rather, he said, “It’s relief that inflation is coming down.”
But it seems to me that the onus is on the this-time-is-different crowd to prove its point. Lots of economists seem to agree. This month, in a Bloomberg survey of 73 forecasters, the median forecast for the likelihood of a recession in the next 12 months was still 60 percent.
There are solid reasons for their pessimism. The Fed’s rate increases work with a lag; their full force will hit the economy over the coming months. Rising interest rates have already dug into home sales volume and prices and put pressure on smaller banks. Retail sales adjusted for inflation have fallen. In addition, there are special factors that are dangerous for the economy. Russia’s attempted embargo of Ukraine’s Black Sea ports has caused wheat prices to spike. The resumption of student loan payments will force many consumers to cut back on spending.
When the sun is out and the birdies are tweeting, it seems churlish to predict bad times ahead. But I’m sticking with my recession forecast.
Outlook: Brett Ryan, Justin Weidner, Matthew Luzzetti and Amy Yang
The Federal Reserve’s Federal Open Market Committee will raise the federal funds rate another quarter of a percentage point on Wednesday, Brett Ryan, Justin Weidner, Matthew Luzzetti and Amy Yang of Deutsche Bank predicted in a client note on Friday. Chair Jerome Powell “is likely to emphasize that further evidence is needed to have confidence inflation will be tamed,” they wrote. Nevertheless, the Deutsche Bank team is sticking with its forecast that this will be the Fed’s last rate increase of this cycle.
Quote of the Day
“Just ask yourself a question: Is it possible in a democratic society for unelected central bankers to ask the government and legislators to trim the inflationary spending plans on which they were elected?”
— Masaaki Shirakawa, former governor of the Bank of Japan, “Time for Change” (2023)
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July 25, 2023 at 02:00AM
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Opinion | Sorry, but I Still Think a Recession Is Coming - The New York Times
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