Banks Withdraw Recession Warnings

When financial market participants come to a firm agreement about something, the opposite will likely happen.

Economists spent the entire second half of 2022 calling for an impending recession. They disagreed on timing and severity but agreed that the Fed's restrictive rate policy would be the trigger.

In the U.S, the National Bureau of Economic Research defines a recession as “A significant decline in economic activity that is spread across the economy and that lasts more than a few months.“

Yet, despite four more 25 bps hikes, the S&P 500 rose by almost 15% year-to-date.

"People have been using the wrong R-word to describe the economy," Joe Brusuelas, chief economist at RSM, stated for CBS MoneyWatch. "It's resilience — not recession."

After the latest meeting in July, even the Fed gave up the recession scenario.

“The staff now has a noticeable slowdown in growth starting later this year in the forecast, but given the economy's resilience recently, they are no longer forecasting a recession,” Fed Chairman Powell noted.

While the hiking cycle of 2022/23 represents the fastest pace since the early 1980s, its restrictive effects are largely nullified by inflation.

The real Federal Funds Rate, which marks the nominal rate subtracted for core personal consumption expenditures (PCE) inflation, has only recently turned positive.

The brief 2020 recession left household balance sheets unusually strong. Despite job losses and lockdowns, the Paycheck Protection Program caused savings to surge. Surging asset classes like equities and residential real estate surging only helped the situation.

The Fed wanted to constrain demand-driven inflation by slowing consumer spending, yet the debt-service ratio shows the impact has been modest. This ratio shows the percentage of disposable income used on debt payment, and it is currently near a 40-year low, around 9%.

Although higher interest rates made it difficult to finance new mortgages, existing mortgages have not suffered much. Before the hiking cycle, only 10% of mortgages were adjustable-rate, with most homeowners locking in low rates on 30-year fixed-rate mortgages. Therefore, consumer spending has not been as rate sensitive as it often is in high-velocity hiking cycles.

Then, there is strong support in the labor market.

Since the recovery started in May 2020, the market has created more than 25 million jobs — even in the face of significant Tech sector layoffs through 2022. According to the JOLTS survey, there are still more than 9.5 million unfilled positions. With unemployment at 3.5%, it marks 18 months in a row below 4%. This streak is the longest one since the 1970s.

Historically speaking, soft landings have been hard to pull off.

According to Deutsche Bank, since the 1950s, each period of U.S. disinflation driven by Fed policy tightening has coincided with a U.S. recession.

Michael Gapen, head of U.S. economics at Bank of America, gives recession odds of 35-40%.

“We still think the most likely alternative (to soft landing) is a mild recession,“ Gapen said, giving the most optimistic outcome with stronger GDP growth odds of just 10-15%.