The writer is chair of Rockefeller International
Economists tend to think in small incremental steps, missing big turns in the story, which helps explain why their consensus view had not forecast a single US recession since records began in 1970 — until now.
For the first time, economists as a group not only expect a recession in America in the next year, but give it a very high probability, more than 60 per cent. Given their record, it’s worth asking whether the consensus is, in fact, unlikely.
With inflation at four-decade highs and central banks raising rates aggressively and in a way that has seldom been so well telegraphed, a recession does seem inevitable. Still, as John Maynard Keynes once warned, “the inevitable never happens and the unexpected constantly occurs.”
The case for the unexpected scenario — no recession in the coming months — would start with inflation declining rapidly. That would allow the Fed to back off from further tightening. Just when the consensus has come to accept that inflation will be higher for longer, and not “transitory” as previously assumed, the easing of supply chain bottlenecks could lower inflation faster than expected.
The signs include cargo shipping prices plummeting, delays at ports shortening and the Fed’s “supply chain pressure index” coming down sharply. China’s economy is in a funk and is exporting slower inflation to the rest of the world. Goods inflation is decelerating with prices for everything from used cars to energy now in decline.
Many still assume that because an unusually tight labour market is driving up wages at a rapid pace, the Fed will have to act as it did in the early 1980s under Paul Volcker — raising rates aggressively and averting an inflationary wage-price spiral by inducing a recession.
But for now America’s economy still seems far away from recession territory. Weak growth in the first half of this year vanished in the third quarter, when US GDP grew at an annual rate of 2.6 per cent. Disposable incomes are keeping pace with inflation, encouraging healthy growth in consumer spending. Spending on travel is stronger now than on the eve of the pandemic.
The private sector is spending too, with corporate capital expenditure growing much faster than business revenues and earnings. The unemployment rate also remains very low at 3.7 per cent and has barely budged despite all the Fed tightening. None of this is what one would expect on the eve of a recession.
The tight labour market does push up wage inflation but some analysts are holding out the hope that with job openings coming off significantly from the all-time highs of March this year, wage growth too will cool shortly. The public expects inflation to fall back into the low single digits, not remain stuck near double digits, as was the case in the 1980s. So today there is less pressures on the Fed to keep raising rates.
Lower inflation would further boost the confidence of American consumers, who are in unusually strong financial shape. Bank deposits swelled during the pandemic, and $2.5tn of that cash is still in the banks. Personal net worth is still about $25tn higher than before the pandemic. The debts that imploded in the Great Recession of 2007-2009 have largely vanished: today nearly 70 per cent of home buyers have FICO credit scores in the top tier — over 760 — compared with 20 per cent before the crisis.
While we have been conditioned to expect economic shocks to be negative, there is always the possibility of a “bluebird” event bringing unexpected joy. A warm winter or peace in Ukraine would lower energy bills, helping to slow inflation and raise economic growth.
This is hardly the most likely scenario and compared with economists, who typically call recessions months after they have begun, markets have a good forecasting record. Though markets can send false signals, showing jitters before downturns that never arrive, they also anticipate real recessions consistently. Going back to the second world war, the US stock market has typically fallen at least 20 per cent and bond traders have always pushed short-term yields above long-term yields in the months before a recession. Both of those market signals are warning of a recession now, so to picture alternate outcomes may be magical thinking.
Still, when the consensus is so strong, anchored by economists whose recession forecasting record is so poor, it is hard not to think of that quote from Keynes. The unexpected is a constant in markets and the economy, which suggests we should at least entertain the possibility that a recession is not inevitable.