Be prepared for an impact when everyone expects to have a soft land. That’s the lesson of recent economic history — and it’s an uncomfortable one for the US right now.
A summer in which inflation trended lower, jobs remained plentiful and consumers kept spending has bolstered confidence — not least at the Federal Reserve — that the world’s biggest economy will avoid recession.
A last-minute deal To avoid a shutdown, you push one immediate risk into the future. The fourth quarter GDP could be impacted by a major auto-strike, the resumed repayment of student loans, or a government shutdown.
Add those shocks to other powerful forces at work on the economy — from dwindling pandemic savings to soaring interest rates and now oil prices too — and the combined impact could be enough to tip the US into a downturn as early as this year.
Here are Sixth, reasons why A recession remains Bloomberg Economics’ base case. They range from the wiring of the human brain and the mechanics of monetary policy, to strikes, higher oil prices and a looming credit squeeze — not to mention the end of Taylor Swift’s concert tour.
The bottom line: history, and data, suggest the consensus has gotten a little too complacent — just as it did before every US downturn of the past four decades.
Soft Landing Calls Always Precede Recessions…
“The most likely outcome is that the economy will move forward toward a soft landing.” Janet Yellen was the then San Francisco Fed president in October 2007. This was just two months prior to the Great Recession. Yellen wasn’t alone in her optimism. Soft landing calls are often heard before a hard landing.
Why is it difficult for economists to predict recessions? One reason is Simply put, forecasting is the process of predicting. It typically assumes that what happens next in the economy will be some kind of extension of what’s already happened — a linear process, in the jargon. But recessions are non-linear events. The human mind isn’t good at thinking about them.
Here’s an example that focuses on unemployment, a key gauge of the economy’s health. The Fed’s latest forecast is for the jobless rate to edge higher from 3.8% in 2023 to 4.1% in 2024, That’s a continuation of the current trend, and one that would see the US skirting a recession.
But what if there’s a break in the trend — the type of sudden shift that occurs when the economy goes into a dive? Bloomberg Economics used a nonlinear model to forecast the path most likely for the unemployment rates, as well as the risk distribution around this path.
The main takeaway is Risks are Unemployment is heavily skewed towards being higher.
…And Fed Hikes Are About to Bite Hard
“Monetary policy,” Milton Friedman said it best: “operates with long and variable lags.” A subtlety in this is This is the “variable” Can refer to not only differences between individuals recession and another — but also to different parts of the economy within a single cycle.
Optimists who believe in a soft landing point out that manufacturing has enjoyed a successful year. is The bottoming out of the housing market and reaccelerating. The problem isThey are are The areas where the rate increases have the most immediate impact on the real world.
The parts of the economy which are important for the recession call — above all the labor market — lags are The average length of time between 18 and 24 months.
That means the full force of the Fed’s hikes — 525 basis points since early 2022 — won’t be felt until the end of this year or early 2024. This will give stocks and housing a new impetus to fall. It’s premature to say the economy has weathered that storm.
The Fed might not be finished yet. Central bankers have penciled in another rate hike.
A Downturn Is Hiding in Plain Sight in the Forecasts…
Against the backdrop of that monetary squeeze, it’s little wonder that some indicators are Warning signs are already visible. Bloomberg Economics examined measures that were already flashing warning signals. are especially important for the emThe following are some examples of how to useent academics who’ll officially declare whether the US is in recession If you don’t like it, then you can leave.
That determination, by the National Bureau of Economic Research, typically isn’t made until several months after the recession The recession began. But the NBER’s slump-dating committee identifies six indicators that weigh heavily in the decision, including measures of income, employment, consumer spending and factory output.
Using consensus forecasts for those key numbers, Bloomberg Economics built a model to mimic the committee’s decision-making process in real time. It matches past calls fairly well. What it says about the future: There’s a better-than-even chance that sometime next year, the NBER will declare that a US recession In the final months of 2023, we will start.
In short: if you look at the gauges that matter most to America’s recession-deciders — and where most analysts reckon they’re headed — a downturn is Already on the cards
…And That’s Before These Shocks Hit
This assessment is a good example. is mostly based on forecasts delivered over the past few weeks — which might not capture some new threats that are The threat of knocking the economy off track. These include:
- Auto Strike: The United Auto Workers union has called a walkout at America’s Big Three auto firms, the first time they’ve all been targeted at the same time. The union expanded its strike to include 25,000 workers on Friday. The industry’s long supply chains means stoppages can have an outsize impact. In 1998, a 54day strike by 9,200 workers at GM led to a reduction of 150,000 in employment.
- Student Bills: This month, millions of Americans are going to start receiving their student loan bills after the three-and-a-half-year freeze ended. Resuming payments may reduce annualized growth by 0.2-0.3% in the fourth quarter.
- Oil Spike: A surge in crude prices — hitting every household in the pocket book — is One of the few reliable indicators of a recession is coming. Oil prices are up nearly $25 since their summer lows and now exceed $95 per barrel.
- Yield Curve A The September sell-off drove the yield on Treasuries 10-years to its highest level in 16 years, at 4.6%. Already, higher borrowing rates for a longer period of time have pushed equity markets down. These costs could also threaten the housing recovery and discourage companies from investing.
- Global Slump The rest could drag down the US. China, the world’s second-largest economy, is a major threat. is A real estate crisis has gripped the country. In the euro zone, lending is contracting at a faster pace than in the nadir of the sovereign debt crisis — a sign that already-stagnant growth is Set to lower
- Shutdown in the government: A 45-day deal to keep the government open has kicked one risk from October into November – a point where it could end up doing more damage to the fourth quarter GDP numbers. Bloomberg Economics estimates each week of the shutdown subtracts about 0.2 percentage points from annualized GDP, but that most of this is recovered once the government opens.
Beyonce Can Only Do So Much…
The core argument for soft landings is the strength of spending by households. Unfortunately, history suggests that’s not a good guide to whether a recession is imminent or not — typically the US consumer keeps buying right up until the brink.
What’s more, the extra savings that Americans amassed in the pandemic — thanks to stimulus checks and lockdowns — are Running out. There’s a debate over how fast, but the San Francisco Fed calculated that they’d all gone by the end of September. Bloomberg calculations reveal that the poorest 20% of the population has less cash in their pockets than they had before Covid.
Americans spent a lot of money on hit entertainment this summer. Beyonce’s and Taylor Swift’s sold-out concerts and the Barbie and Oppenheimer movie were also added. a remarkable $8.5 billion The third quarter GDP. It looks like the last gasp. After concerts and savings have run out, the powerful consumption drivers are now replaced by blank spaces.
The future is revealed by the credit-card delinquency rate, which has risen, especially among young Americans. And parts of the auto loan market have also seen a rise. are It’s bad for you.
…And the Credit Squeeze Is Just Getting Started
One indicator has a very good track record in predicting recessions is the Fed’s survey of senior loan officers at banks, known as the SLOOS.
According to the latest data, about half of all large and midsized banks are insolvent. are Imposing tougher criteria on commercial and industrial loan applications. Aside from the pandemic period, that’s the highest share since the 2008 financial crisis. The impact is set to be felt in the fourth quarter of this year – and when businesses can’t borrow as easily, it usually leads to weaker investment and hiring.
Arguments in Defense
The optimists will also be able to marshal strong evidence.
Vacancies: A The view that the labor markets are a key factor in a hard landing is a major part of the argument. is Overheated and cooling will require an increase in unemployment. But perhaps there’s a less painful path? That’s the argument made by Fed Governor Chris Waller and staff economist Andrew Figura in summer 2022: that a drop in vacancies might take the heat out of wage gains, even as unemployment stayed low. As of now, the data is They are arguing for their position.
Productivity: In the late 1990s, rapid productivity gains — the result of the IT revolution — allowed the economy to outperform without the Fed having to hit the brakes too hard. Fast forward to 2023, and the creative destruction sparked by the pandemic, plus the potential in artificial intelligence and other new technologies, might mean a fresh surge in productivity — keeping growth on track and inflation in check.
Bidenomics: President Joe Biden’s embrace of industrial policy — he’s been doling out subsidies to the EV and semiconductor industries — hasn’t won him any friends among free market fundamentalists. It has also led to increased business investment which could help keep the economy growing.
Damp SquibsThe shocks that are expected may not be enough to change the dial. If the auto strikes ends quickly, government remains open and student loans are paid are at the low end of our estimates — the Biden administration is offering new programs to cushion the impact — then the drag on fourth quarter GDP could end up being a rounding error. Our recession call isn’t dependent on all those shocks hitting, but if none of them do the chances come down.
Pride is a leading indicator of falls
The past few years taught economists a valuable lesson about humility. Forecasting models that were successful in good times, but failed to predict the impact of the pandemic or the war in Ukraine have been completely blown out of the water.
This is a good thing reasons Caution is advised. A soft landing remains possible. But is it likely to happen? The US is facing a combination of Fed hikes and auto strikes, increased oil prices, student loan repayments and global slowdown.
— With assistance by Katia Dmitrieva, Stuart Paul, Andrej Sokol, Alexandre Tanzi, Rich Miller, and Cedric Sam