US Recession 2023: Mixed Economic Signals
Oct 18, 2023
Introduction
As the US economy enters 2023, there is ongoing debate around the potential for a recession in the coming months. While the job market remains resilient with strong hiring levels, other indicators have shown signs of weakness that suggest an economic downturn may be on the horizon.
Adding to the uncertainty are the actions of the Federal Reserve, which began aggressively raising interest rates over a year ago to curb high inflation. Rate hikes aimed at cooling demand have begun to impact rate-sensitive sectors like housing and autos. However, their broader economic effects have not fully realized due to typical monetary policy lags.
At the same time, inflation continues to surge above the Fed’s 2% target despite rate increases, leading to concerns the central bank may need to tighten financial conditions even more. This risks potentially slowing growth too much and tipping the economy into recession. Another complication is increased geopolitical uncertainty from issues like the ongoing war in Ukraine.
Amid these shifting dynamics, investors and analysts scrutinise various economic indicators to gauge the economy’s direction in 2023. Traditional recession signals like an inverted yield curve point to high recession probability, while labour market strength remains resilient. Yet declines in leading indexes and other metrics warn of potential weakness on the horizon.
With contradictory signals emerging from different data points, there are good-faith arguments on both sides as to whether a recession can be avoided or is now inevitable. Various crosscurrents could impact growth and inflation in unforeseen ways, so uncertainty around the 2023 outlook remains high. This article will analyze the latest trends across key indicators to assess where recession risks may lie in the new year.
The US Job Market Remains Resilient
The US job market continues to defy expectations of a recession, adding 431,000 jobs in March. The unemployment rate held steady at 3.6%, near a half-century low. Hiring has remained strong across many industries, such as leisure/hospitality, professional services and manufacturing. Wages are also up 5.6% over the past year, outpacing inflation. While some data points to slowing job growth, employers still struggle to find workers. The tight labour market supports consumer spending and has helped keep the economy expanding despite rising interest rates and high inflation. However, sustained strength in hiring may also increase “overheating” risks and fuel even higher prices.
The resilience of the job market can be attributed to several factors. First, consumer spending has remained strong despite high inflation, supported by savings built up during the pandemic, a strong job market, and rising wages. This steady demand has allowed companies across many sectors to continue hiring. Second, the mix of job gains is shifting towards services jobs in industries like hospitality and healthcare as demand returns with the waning of the pandemic.
Third, the ageing of the population has led to more job openings in healthcare. Fourth, the rise of remote work has expanded the geographic reach of hiring for many employers. Fifth, the shortage of workers for critical roles like trucking and logistics has forced wage growth in these areas. Sixth, increased business investment and spending on technology and automation has driven the hiring of IT workers and engineers. Seventh, the energy sector has seen job gains with high oil and gas prices. However, risks remain, such as potential layoffs if consumer spending slows significantly. The path forward will depend on how inflation and consumer demand evolve.
Leading Indicators Point to Slowdown
Leading economic indicators pointing to a potential slowdown. Here are some key points:
– The Conference Board’s Leading Economic Index fell 0.3% in February, continuing a downward trend that has brought the index down nearly 4% since July 2021. This index signals future economic turns, so sustained weakness is concerning.
– Major components of the index, like jobless claims, stock prices, and manufacturing orders, have been declining, dragging down the overall index.
– The coincident index, which measures current economic activity, has also fallen slightly. This suggests growth is already starting to moderate.
– If the leading indicators continue falling significantly, it would increase the risks of a recession starting in late 2023, given these indicators tend to lead recessions by around 7 months.
– However, leading indicators are not definitive recession predictors. Other factors like consumer and business spending, jobs data, and inflation trends must also be considered.
In summary, the leading indicators bear close watching as an early warning of potential economic slowing ahead. But they are not yet at levels that guarantee recession. The economy’s path depends on how these indicators trend in the months ahead. Let me know if you need any clarification or have additional questions!
Exploring the Nuances of Yield Curve Inversion
In economic forecasting, the yield curve inversion is often regarded as a reliable harbinger of impending recessions. However, the dynamics of the financial world have evolved, rendering this signal more intricate and less straightforward than in the past. As we delve into the details, several crucial facets demand our attention.
First and foremost, the Federal Reserve’s influence on Treasury rates has introduced a layer of complexity. The extensive bond purchases by the Fed have substantially impacted long-term yields, making it difficult to interpret the yield curve inversion in isolation.
Furthermore, the yield curve isn’t uniformly inverted. For instance, the inversion is not as pronounced when examining the 5-year note versus the 30-year bond. This variance in inversion levels adds uncertainty to the signal’s potency.
Amid this economic backdrop, inflation expectations are running high. The Federal Reserve, in its quest to combat rising prices, has indicated a potential need for interest rates to surpass the neutral rate and remain elevated for an extended period. This could sustain the curve inversion without necessarily culminating in a recession.
Moreover, recent rate hikes have already led to significantly tightening financial conditions. While this exerts a drag on economic growth, it might alleviate some of the pressure on the Fed to pursue aggressive rate hikes.
The labour market remains remarkably tight, supporting consumer spending in the short term. However, higher interest rates are beginning to impact sectors sensitive to changes in borrowing costs, such as the housing market.
Ultimately, the trajectory of inflation will prove pivotal in determining whether a soft or hard landing for the economy is feasible. Should inflationary pressures persist, the spectre of recession will continue to cast a shadow over financial markets.
In summary, while the yield curve inversion remains a topic of concern, its interpretation in today’s economic landscape is far from straightforward. The path of inflation will be the linchpin in deciding whether a gentle descent or a more tumultuous landing lies ahead.
Is the Ongoing Treasury Yield Curve Inversion Predicting a 2023 Recession?
The Treasury yield curve is one of the most watched recession indicators. Here’s a breakdown:
– The yield curve plots the interest rates of Treasury bonds of differing maturities, typically from 3 months to 30 years.
– A standard yield curve slopes upward, with longer-term rates higher than short-term. This reflects investors’ expectations for future interest rate moves.
– When the curve inverts, with short-term rates rising above long-term, investors expect policy rates to be cut in the future to stimulate the economy.
– Every U.S. recession in the past 60+ years has preceded a Treasury yield curve inversion.
– However, the timing and length of inversions preceding recessions varies – inversions can occur 12-24 months prior.
– When short-term borrowing costs exceed returns on long-term investments, it can discourage business spending and investment.
– Banks also face profit pressures from funding long-term loans at a loss when curves are inverted.
– So, inversions reflect market expectations that the Fed’s interest rate hikes will sufficiently cool demand to trigger an economic downturn.
The prolonged inversion since mid-2022 fuels heightened recession risk predictions for late 2023 or 2024.
Federal Reserve’s Efforts to Control Inflation
The Federal Reserve’s ongoing efforts to control inflation have been a topic of significant interest and concern. In response to the rapid rise in inflation experienced in recent times, the Federal Reserve has implemented measures to manage and mitigate its impact on the economy. One of the critical tools at the central bank’s disposal is the adjustment of interest rates.
The Federal Reserve has been gradually raising interest rates to combat inflationary pressures. These rate hikes are aimed at cooling down the economy and reducing the demand for goods and services, thereby curbing rising prices. The latest data suggests that the Federal Reserve has increased interest rates multiple times in the past year, with expectations of further hikes in the future.
However, it is essential to note that the effectiveness of interest rate adjustments in controlling inflation is subject to various factors and can have both intended and unintended consequences. While higher interest rates may help rein in inflation, they can also lead to a broader economic slowdown. For instance, the housing sector and manufacturing activity have been impacted by the increased cost of borrowing, which can dampen consumer spending and business investment.
Looking ahead, the Federal Reserve faces the challenge of striking the right balance between controlling inflation and ensuring sustainable economic growth. As inflation concerns persist, the central bank will closely monitor economic indicators and adjust its policies to maintain price stability while supporting overall economic peace and prosperity.
Economic Indicators and Recession Risk Assessment For Recession 2023
Here are some additional economic indicators that investors are examining to gauge recession risks:
Consumer Confidence: Weakening consumer sentiment could point to pullbacks in discretionary spending, a key pillar of economic growth. The Conference Board Consumer Confidence Index warrants close watching.
GDP Trends: Two consecutive quarters of declining GDP is a rule-of-thumb definition of a technical recession. First quarter 2023 results in late April will be heavily scrutinized.
Corporate Earnings: Profitability margins are declining for many firms as input costs rise. Further earnings misses or downgrades to guidance could reflect Flagging demand.
PMI Data: The ISM Manufacturing and Services PMIs provide timely input on business conditions outside of jobs/spending data. Declining PMIs corroborate softening activity.
Truck Shipments: Weekly data from the American Trucking Association tracks ground freight – a backbone of commerce. Sustained declines signal weak consumption.
Initial Jobless Claims: While headline employment has increased, rising layoffs would show in initial claims trends. Sharp increases could foreshadow broader weakness.
Inventory Levels: Excess stockpiles due to supply chain snags led some companies to rein in orders, reducing downstream demand impacts. Leaner inventories help activity.
Housing Starts/Permits: Steep housing corrections lowered starts by over 30% y/y in 2022 on affordability concerns. Retrenchment ripples through related sectors.
Examining multiple data points paints a fuller picture of the economy’s trajectory beyond any single metric in this period of uncertain transition.
Are Leading Economic Indicators Signaling an Impending Downturn?
Here are some of the major leading economic indicators that are currently suggesting a potential economic downturn:
– Treasury Yield Curve Inversion – With short-term rates higher than long-term, the yield curve has been inverted since July 2022, which has preceded past recessions.
– Declining LEI – The Conference Board’s Leading Economic Index, composed of factors like jobless claims and stock prices, has fallen nearly 4% over the past year, foreshadowing recessions.
– Weakening Regional PMIs – Both manufacturing and services PMIs from regions like the Midwest have softened significantly in recent months.
– Inventory Buildups – Businesses added to stockpiles rapidly in Q1 2023 amid weak demand, seen as destocking may dent production.
– Pullback in Housing Starts – Homebuilders have drastically reduced new construction as mortgage rates have doubled, cooling the critical housing sector.
– Slumping Consumer Sentiment – Surveys from the University of Michigan show Americans at their gloomiest since the 1980 recession.
– Rising Initial Jobless Claims – While low, weekly layoffs have risen noticeably in tech and real estate sectors lately.
– Profit Margin Squeezes – Corporate earnings are declining as companies face higher input costs, potentially limiting investment.
– Slowing GDP Growth – After two straight quarters of negative growth, most forecasts see a mild recession in 2023.
The confluence of weakness across several leading metrics has increased concerns around rising recession probabilities in the year ahead.
Outlook for the 2023 Recession: A Contrarian Perspective
In contrast to the prevailing view, some experts present a contrarian perspective on the relationship between the worker gap and sustainable wage growth. Phillips and Mericle argue that while progress has been made in reducing the jobs-workers gap, further narrowing is necessary to support sustainable wage rates.
According to their analysis, the worker’s gap has decreased from 5.9 million to 4 million. However, it is essential to note that this reduction has been primarily driven by a decline in job openings rather than an increase in employment. While this trend is positive, Phillips and Mericle contend that the jobs-workers gap must shrink to reach approximately 2 million to facilitate sustainable wage growth.
Their argument stems from the belief that a smaller workers’ gap reflects a more balanced labour market, where job supply aligns more closely with labour demand. In such a scenario, employers would face increased worker competition, leading to upward wage pressure. This, in turn, could contribute to sustained wage growth and improved living standards for workers.
However, it is worth noting that the contrarian view presented by Phillips and Mericle may not be universally accepted. Other economists and analysts may hold differing opinions regarding the threshold at which the jobs-workers gap becomes compatible with sustainable wage growth. Economic conditions, policy factors, and market dynamics can all influence the relationship between the labour market and wage rates.
Ultimately, ongoing research and analysis will shed further light on the complexities of the worker gap and its implications for wage growth. Continued monitoring and evaluation of labour market dynamics will be essential in informing policymakers and stakeholders on strategies to promote sustainable wage growth and overall economic well-being.
Conclusion
In conclusion, the US job market appears stable, but it is essential to consider other economic indicators that may pose financial risks. While the Federal Reserve’s efforts to manage inflation and interest rates are ongoing, policymakers should consider strategies to stimulate production and foster sustainable economic growth. This shift in focus from reducing consumption to boosting production can contribute to achieving low inflation rates, currency stability, and faster overall growth.
Investors should closely monitor various data points, including employment figures, inflation rates, and central bank policies, to make informed investment decisions. Investors can adapt their strategies and position themselves by staying informed about the evolving economic landscape.
Furthermore, it is worth noting the contrarian view presented by Goldman Sachs Research, which suggests that the likelihood of a recession in 2023 may not be as high as previously thought. This highlights the importance of considering diverse perspectives and continuously evaluating economic indicators to understand the current and future economic outlook comprehensively.
As economic conditions evolve, policymakers, analysts, and investors must remain vigilant and adaptable. By closely monitoring key indicators and engaging in ongoing analysis, stakeholders can navigate the dynamic economic landscape and make informed decisions to promote financial stability and growth.
FAQ
What is the likelihood of a recession in the US in 2023?
Experts have differing opinions regarding the likelihood of a recession in the US in 2023. While some economic indicators suggest a recession, Goldman Sachs Research estimates a lower risk of a US recession in 2023, with a probability of 35%, in contrast to the consensus estimate of 65%.
What are the economic indicators that suggest a recession?
The Conference Board’s Leading Economic Index has declined by nearly 4% over the past six months. The treasury yield curve has been inverted since July 2022, indicating a high probability of a recession by the end of the year.
What challenges does the Federal Reserve face in managing inflation and interest rates
The Federal Reserve’s efforts to combat inflation have led to interest rates and inflation concerns. The central bank raised interest rates to control inflation, which has led to a broader economic slowdown affecting the housing sector and manufacturing activity. Moreover, a new report suggests that the interest rate increases by central banks may not be enough to bring global inflation back down to pre-pandemic levels.
How should policymakers achieve low inflation rates, currency stability, and faster growth?
Policymakers must shift their focus from reducing consumption to boosting production. This requires generating additional investment, improving productivity, and capital allocation, which is critical for growth and poverty reduction.
What is the contrarian view offered by Goldman Sachs Research?
Goldman Sachs Research estimates a lower risk of a US recession in 2023, with a probability of 35%, in contrast to the consensus estimate of 65%. David Mericle and Alec Phillips, the chief US economists at Goldman Sachs, suggest that the potential for a recession in 2023 is lower than the consensus estimate of 65%. They believe that a continued period of below-potential growth can gradually rebalance supply and demand in the labour market and dampen wage and price pressures with a limited increase in the unemployment rate.
