I don’t like making big, bold macro predictions.
There are a lot of unknown variables involved, and even if I get my macro forecast right, it probably won’t help my portfolio because the market’s reaction to economic data is more important than the data itself.
Last week, Michael and I were on Plain English with Derek Thompson discussing the confusing nature of the current macro environment.
You can easily talk in so many different scenarios these days that it’s not hard to see both sides of many economic debates.
But Derek held our feet to the fire and forced us to choose a side: Gun to the head – recession or not in 2023?
I had to choose, I said there is no recession. So did Derek and Michael.
This answer came as a surprise to all of us, because if you had asked me the same question 9-10 months ago, I would have definitely said yes to a recession in 2023.
Why?
First, historically, every time we’ve had a big jump in inflation, we’ve needed a recession and an increase in the unemployment rate to bring inflation back:
Another indicator that has been flashing red for some time now is the ever-inverted yield curve:
Short-term bond yields are much higher than long-term bonds, and this is a perfect indicator that a recession is imminent (though not immediately).
If you use market or economic history as a guide, it would be almost impossible to think we can avoid a recession. Plus, things were already going in the wrong direction for inflation, and then the war happened, which made things worse.
In an economy where inflation is low, unemployment isn’t rising much, and GDP growth isn’t taking a huge hit, it almost doesn’t make sense to think about a soft recession.
I think we can buck the trend here for a few reasons:
The labor market remains strong. I have never seen anything like the current job market. There are still businesses that cannot find enough workers. Wages continue to rise (albeit more slowly). The unemployment rate continues to fall.
Workers have probably never had more bargaining power than they do now.
Just look at the difference in salary growth between people who change jobs and people who stay in their current role:
If you change jobs now, you have a better chance of getting paid more than if you stay put.
This is the first time in 40-50 years that workers are finally gaining an upper hand over employers.
Can this last?
Honestly, I don’t know. If that would make sense, we could avoid a major slowdown in the economy.
The consumer was ready to slow down. US households have never been better positioned to weather high inflation or the potential for an economic slowdown.
After the Great Financial Crisis, consumers were already repairing their balance sheets by paying down debt and building savings. Then the pandemic hit, the government sent a bunch of money, people stopped spending because they couldn’t do anything, and the result was trillions of dollars in excess savings.
The combination of increased demand and excess savings has led to an explosion in spending:
Things are finally starting to slow down a bit, but we’re still nowhere near pre-pandemic spending levels.
Once people get a taste for spending money, it’s hard to put that genie back in the bottle.
A recession may be needed to rein in household spending.
The pandemic has disrupted economic logic. One of the biggest economic surprises in a cycle full of them is that nothing is broken yet. There was an assumption that the markets and the economy couldn’t handle higher rates, which is why the Fed kept them so low to begin with.
Not only did borrowing rates rise in 2022, they did so at the fastest rate on record.
But something strange happened – nothing was broken. Yes, financial markets took a hit, but the economy remained resilient. There was no financial crisis. The unemployment rate did not increase.
And inflation is rolling.
Obviously, something can still break.
Perhaps all this excess savings delayed the inevitable. It is still possible for the economy to slow down here or for inflation to pick up again next year. Or maybe we won’t see a recession until 2024 or 2025.
All I know is that I didn’t expect a soft landing when inflation reached 9%, but the job market remains very buoyant, so it feels like there’s a chance to avoid a recession.
If we get a soft landing, markets, rates and the outlook for the economy should probably change. If this happens, I have more questions than answers:
What if a recession is more bullish for the stock market than sustained strength in the economy and labor market?
My assumption was that the Fed would have to cut rates once they messed something up in the economy. That could be good for markets if nothing breaks, but it could also create a headwind if rates stay higher for longer.
If we don’t enter a recession, does that mean the juicy returns investors can get on their short-term savings will be for now?
This would be a positive development for fixed income investors. Now you can earn 4-5% with high quality short term debt instruments. If you want to risk a little more, returns are now in the 6% to 9% range, depending on your risk profile.
Because long-term returns are so much lower than short-term returns, it’s hard to wrap your head around this moment. This may not last, but the Fed is pulling the strings now, who knows?
Does a non-recession cause inflation?
If “everyone” thought we were going to have a recession, but it didn’t, does that put the risk of inflation back on the table? Will businesses start spending more? Will households spend more?
It’s strange to think that managing a soft landing could actually have more economic ramifications.
Is Inflation Falling Because of the Fed or Despite It?
The Fed has made it clear that they want the labor market to soften. And it’s not just that they want wages to stop rising so fast, they also want people to lose their jobs to keep inflation down.
But we now see inflation falling without a commensurate rise in the unemployment rate.
Perhaps the Fed is not responsible for the fall in inflation, and it has more to do with pandemic factors perpetuating it than anything else.
Sign me up for a situation where we can solve this crisis without millions losing their jobs.
Michael and I discuss the possibility of no recession in 2023 and more in this week’s Animal Spirits video:
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Further Reading:
What kind of decline will we get in the economy?
Here’s what I’ve been reading lately: