Ready for the reluctant recession?
Wall Street’s favorite economist just issued a wake-up call, reminding us that sometimes “it’s ok until it isn’t.” That is, during Fed tightening cycles, the economy can appear just fine and continue to hum along — until all at once it falls out of bed.
Ed Hyman, who has been ranked the Street’s top economist for an extraordinary 42 years, cites the 2007-2009 downturn as an example. The housing crisis emerged in 2006; the yield curve inverted in that year’s third quarter, the Fed paused and the economy continued to grow. Two years in, the economy began to meaningfully contract, in the third quarter of 2008. In other words, the downturn took a long time to develop, just as it has in this cycle.
Many investors and analysts have been looking for a recession over the past nine months; in the next quarter that elusive downturn may finally arrive.
Hyman, for one, is expecting zero growth in this (second) quarter, to be followed by three subsequent down quarters. Worse, he thinks unemployment will increase to 5.2 percent a year from now; he calls that a “hard landing.”
Why the gloom? A contracting money supply, credit tightening, a yield curve that has been inverted for six months and swooning leading indicators.
Hyman’s firm, ISI Evercore, tracks various sectors. Their trucking survey, which correlates well with overall economic activity, has been in freefall, and even growing industries like tech and airlines look to be rolling over.
A slowdown seems to have been in the works for ages. Last July, Bank of America and financial services group Nomura, among others, began to predict a downturn as early as July 2022. Wells Fargo proposed the recession would occur in the first quarter of this year.
The gloomy forecasts cited high inflation, imminent interest rate hikes and an eventual fall-off in consumer spending as likely to undermine growth; the only question was when the hit might occur and how severe it would be.
But, despite one of the fastest and most abrupt cycles of interest rate hikes on record, dismal stock and bond market losses in 2022, and persistent inflation, the economy has continued to grow, buoyed by consumer spending. First-quarter real growth was only 1.1 percent, to be sure, lower than the expected 2 percent, but nonetheless, Americans shopped and the economy expanded.
What has changed? Mainly, time has passed; most economists reckon it takes 12 to 18 months for changes in monetary policy to impact growth. The Fed started hiking rates in March of 2022 and has increased the Fed Funds Rate nine more times since then. We are therefore about on schedule to see those higher interest rates cut into growth.
Indeed, they already are. The first industry to be hit by higher interest rates is usually housing and, indeed, higher mortgage rates have caused a downturn in housing starts. In April a year ago, construction began on 1.8 million new homes; last month the figure was 1.4 million. A 21 percent fall-off in building permits from last year suggests the industry will remain depressed.
Consumer spending has held up well through this cycle, in part because of savings piled up during the pandemic, as Americans received sizeable COVID relief money, and also because the job market has remained robust. But spending is beginning to falter — especially on goods, which bleeds into manufacturing.
The volatile Empire State Manufacturing Index plunged into negative territory in May, indicating contraction, for the fifth time in the last six months. The broader ISM for manufacturing has also trended lower, with the April reading at 47, down from 55 a year ago. Manufacturing employment has essentially flatlined.
Americans are still opening their pocketbooks to spend on services, especially on eating out and travel. Young people particularly, according to a recent survey by McKinsey & Company, are eager to splurge. But reports show that group also maxing out their credit cards, so their spending spree could be short-lived.
Bank of America reports that total credit card spending per household fell 1.2 percent in April from a year ago, the first year-over-year drop since February 2021. That figures: The job market, which has been incredibly tight for more than two years, has begun to crack. The total number of jobs available has declined and layoffs have increased, according to recent JOLTS reports, while new unemployment claims, while still low, are trending higher.
Consumer sentiment, meanwhile, is falling, with the University of Michigan May reading down 9 percent from April and also off from the year-earlier level. Overall leading indicators have been sliding for months. In the past six months the LEI is off 4.5 percent; the rate of decline has been accelerating.
Consumers are not the only group that is gloomy. Small-business owners surveyed by the National Federation of Independent Businesses registered increased pessimism in April, with most declaring inventories too high amid expectations that sales are trending lower. Only 3 percent thought it was a good time to expand. Gulp.
Hyman and others were shocked that the Fed raised rates again at the last meeting, just as three large banks were failing. Never before has our central bank tightened the screws in the midst of a financial crisis. Now, some are concerned that the Fed’s single-minded (and belated) fixation on inflation could cause a harsher recession.
Meanwhile, debate over raising the debt ceiling is creating even more uncertainty, anathema to growth and to investors. GOP demands for federal spending cuts and reforms are worthwhile, but the longer the negotiations go on, the more businesses may put investments on hold.
Overall, we’ve had all the prerequisites for a downturn but none has occurred. Investors want the recession to show up, so we can return to a more benign interest rate environment. My view: Be careful what you wish for.
