Why a US recession is still possible and imminent
Inflation is trending lower, jobs are plentiful, and consumer spending is up, boosting confidence that the world’s largest economy will avoid recession.
Brace for impact when everyone expects a soft landing. That is the lesson of recent economic history, and it is an unsettling one for the United States right now.
A summer in which inflation trended lower, jobs remained plentiful, and consumers kept spending has boosted confidence in the world’s largest economy, not least at the Federal Reserve.
A last-minute agreement to avoid a government shutdown pushes one immediate risk into the future. However, a major auto strike, the resumption of student-loan repayments, and a shutdown that could return after the stop-gap spending agreement expires could easily shave a percentage point off GDP growth in the fourth quarter.
When those shocks are combined with other powerful economic forces — from dwindling pandemic savings to soaring interest rates and now oil prices — the combined impact could be enough to tip the US into a downturn as early as this year.
Here are six reasons why Bloomberg Economics continues to forecast a recession. They range from human brain wiring and monetary policy mechanics to strikes, higher oil prices, and a looming credit squeeze — not to mention the end of Taylor Swift’s concert tour.
Recessions are always preceded by soft landing calls…
“The most likely outcome is that the economy will move forward toward a soft landing.” So stated Janet Yellen, then-President of the Federal Reserve Bank of San Francisco, in October 2007, just two months before the Great Recession began. Yellen was far from alone in her optimism. Soft landing calls peak alarmingly frequently before hard landings.
Why is it so difficult for economists to predict recessions? One reason is the nature of forecasting. It typically assumes that what happens next in the economy will be a continuation of what has already happened — a linear process, in economic parlance. Recessions, on the other hand, are non-linear events. They are difficult for the human mind to contemplate.
Here’s an example that focuses on unemployment, which is a key indicator of the health of the economy. According to the Fed’s most recent forecast, the unemployment rate will rise from 3.8% in 2023 to 4.1% in 2024, continuing the current trend and putting the US on the verge of a recession.
But what if the trend breaks — the kind of abrupt shift that occurs when the economy crashes? Bloomberg Economics forecasted not only the most likely path for the unemployment rate, but also the distribution of risks around that path, using a model designed to account for these nonlinearities.
The main takeaway is that the odds are heavily stacked against higher unemployment.
…And the Fed’s hikes are about to bite hard.
“Monetary policy operates with long and variable lags,” Milton Friedman famously stated. One nuance is that the term “variable” can refer not only to differences between recessions, but also to different parts of the economy within a single cycle.
Stocks have had a good year, manufacturing is bottoming out, and housing is reaccelerating, according to soft-landing optimists. The problem is that those are the areas with the shortest lag time between rate hikes and real-world impact.
Lags are typically 18 to 24 months for the parts of the economy that matter for calling a recession, most notably the labor market.
That means the full impact of the Fed’s rate increases — 525 basis points since early 2022 — won’t be felt until the end of the year or early 2024. When this occurs, it will provide new impetus for stocks and housing to fall. It is too soon to declare that the economy has weathered the storm.
And the Fed may not have finished raising interest rates yet. Central bankers have penciled in one more rate hike in their latest projections.
In the forecasts, a downturn is hiding in plain sight…
It’s no surprise that some indicators are already flashing warning signs against the backdrop of that monetary squeeze. Bloomberg Economics examined measures that are particularly important for the eminent academics who will officially declare whether the United States is in recession or not.
The National Bureau of Economic Research typically does not make that determination until several months after the recession has begun. The NBER’s slump-dating committee, on the other hand, identifies six indicators that weigh heavily in the decision, including income, employment, consumer spending, and factory output.
Bloomberg Economics created a model to simulate the committee’s decision-making process in real time using consensus forecasts for those key numbers. It does a good job of matching previous calls. What it means for the future: There’s a better-than-even chance that the NBER will declare that a US recession began in the final months of 2023 sometime next year.
In short, if you look at the indicators that matter most to America’s recession-decision-makers — and where most analysts believe they’re headed — a downturn is already on the horizon.
…And that’s before the shocks arrive.
That assessment is largely based on forecasts issued in recent weeks, which may have missed some new threats that threaten to derail the economy. Among them are:
The United Auto Workers union has called a walkout at America’s Big Three automakers, the first time all three have been targeted at the same time. On Friday, the strike was expanded to include approximately 25,000 workers. Because of the industry’s long supply chains, stoppages can have a significant impact. In 1998, a 54-day strike by 9,200 GM workers resulted in a 150,000 job loss.
Student Loans: After a three-and-a-half-year moratorium, millions of Americans will begin receiving student loan bills again this month. The resumption of payments could reduce annualized growth by another 0.2-0.3% in the fourth quarter.
Spike in Oil Prices: A rise in crude prices, which hits every household’s wallet, is one of the few truly reliable indicators that a downturn is on the way. Oil prices have risen nearly $25 from their summer lows, and are now trading above $95 per barrel.
Yield Curve: Following a September selloff, the yield on 10-year Treasuries reached a 16-year high of 4.6%. Higher-for-longer borrowing costs have already weighed on equity markets. They may also jeopardize the housing recovery and deter businesses from investing.
Global Slump: The rest of the world may drag the United States down. China, the world’s second-largest economy, is mired in a real-estate crisis. Lending in the eurozone is contracting faster than it was at the height of the sovereign debt crisis, indicating that already-stagnant growth will slow further.
Government Shutdown: A 45-day agreement to keep the government open has pushed one risk from October into November, potentially causing more damage to fourth-quarter GDP figures. Bloomberg Economics estimates that each week of the shutdown reduces annualized GDP growth by about 0.2 percentage point, with most, but not all, of that recouped once the government reopens.
Beyonce is only capable of so much...
The strength of household spending is central to the soft-landing argument. Unfortunately, history suggests that this is not a good indicator of whether a recession is imminent or not — typically, the US consumer continues to buy right up until the point of no return.
Furthermore, the additional savings amassed by Americans during the pandemic — thanks to stimulus checks and lockdowns — are running out. There’s some disagreement about how quickly, but the San Francisco Fed estimated that they’d all be gone by the end of September. According to Bloomberg calculations, the poorest 80% of the population now has less cash on hand than they did before Covid.
Americans splurged on a wave of hit entertainment this summer. The Barbie and Oppenheimer films, as well as Beyonce and Taylor Swift’s sold-out concert tours, contributed a whopping $8.5 billion to third-quarter GDP. That appears to be a final farewell. With savings depleted and concerts completed, powerful consumption drivers have been replaced by a void.
Providing insight into the shape of things to come: Credit-card delinquency rates have risen, particularly among younger Americans, and parts of the auto-loan market are also deteriorating.
…And the Credit Crunch is only getting started.
The Fed’s survey of senior loan officers at banks, known as the SLOOS, is one indicator that has a good track record of predicting downturns.
According to the most recent data, roughly half of large and mid-sized banks are imposing stricter criteria for commercial and industrial loans. Aside from the pandemic, this is the highest percentage since the 2008 financial crisis. The impact is expected in the fourth quarter of this year, and when businesses can’t borrow as easily, investment and hiring suffer.
Arguments in Support of the Defense
Of course, the optimists can present some compelling evidence.
Vacancies: A key component of the case for a hard landing is the belief that the labor market is overheated and that cooling it will necessitate an increase in unemployment. But is there a less painful option? In summer 2022, Fed Governor Chris Waller and staff economist Andrew Figura argued that a drop in vacancies would take the sting out of wage increases even if unemployment remained low. So far, the data is supporting their argument.
Productivity: In the late 1990s, rapid productivity gains resulting from the IT revolution allowed the economy to outperform without the Fed having to step on the brakes too hard. Fast forward to 2023, and the pandemic’s creative destruction, combined with the potential of artificial intelligence and other new technologies, may result in a new surge in productivity, keeping growth on track and inflation under control.
Bidenomics: President Joe Biden’s embrace of industrial policy — he’s been doling out subsidies to the EV and semiconductor industries — hasn’t made him popular with free market fundamentalists. However, it has increased business investment, which is another factor that could keep the economy growing.
Damp Squibs: Some of the anticipated shocks may be insufficient to move the dial. If the auto strike is resolved quickly, the government remains open, and student loan repayments are at the low end of our estimates — the Biden administration is offering new programs to mitigate the impact — the drag on fourth-quarter GDP may be a rounding error. Our recession forecast is not contingent on all of those shocks occurring, but if none do, the chances of a recession decrease.
Pride Is a Risk Factor for Falls
The last few years have taught economists a lesson in humility. When confronted with seismic shocks from the pandemic and the Ukraine war, forecasting models that worked well in the past have completely failed.
All of this is reason to be cautious. A soft landing is still possible. Is this, however, the most likely outcome? With the combined impact of Fed hikes, auto strikes, student loan repayments, higher oil prices, and a global slowdown, we believe not.