The Bulls’ Worst Recession Fear: There Won’t Be One
There ain’t gonna be no recession,” Pierre Rinfret, an economist who once advised the Nixon administration, confidently declared in December 1969. Better at attracting publicity than forecasting, he admitted his error after the economy began a downturn that very month that would last through November 1970. Not even his ungrammatical double-negative, which might be construed pedantically as a prediction of a recession, could erase that bombastic blunder.
With that in mind, there nevertheless is justification now to go against Wall Street’s consensus forecast that 2023 is certain to bring a recession. The corollary is that the Federal Reserve will reverse course, begin to ease monetary policy, and power a new bull market.
The strongest support for this scenario is the yield curve, the trace of yields on Treasury securities across maturities. Normally, investors demand a higher return for committing money for a longer period. However, as of Friday, three-month T-bills were yielding 4.420%, roughly the same as the two-year note but significantly above the benchmark 10-year note’s 3.880%.
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Investors’ willingness to accept a lower yield for a lengthier maturity implies that they expect declining long-term interest rates. This implicitly casts doubt on the Fed’s mid-December projections, which put the federal-funds target rate at a median 5.1% by the end of 2023, versus today’s 4.25%-4.50%, and above the yield curve’s current high point. Fed-funds futures see a chance of reaching the central bank’s anticipated year-end level by June, but they price in lower rates in 2023’s second half, down to 4.50%-4.75% by December, according to the CME FedWatch tool.
The rate cuts anticipated by the markets would be consistent with a recession. But some economists cast doubt on the yield curve’s seemingly straightforward message.
An inverted yield curve isn’t sufficient to signal a recession, writes Joseph Carson, former chief economist at AllianceBernstein, on his blog. Banks are lending freely while interest rates, although up from the historically low levels of a year ago, aren’t deterring borrowing by consumers or businesses.
When the yield curve inverted in previous cycles, credit growth slowed sharply, often contracting; this isn’t happening now. And, typically, the fed-funds rate tracks nominal gross-domestic-product growth, he notes. But GDP, measured in current dollars, is up twice as much as the fed-funds median of about 4.4%. The tight credit conditions that precede a recession also are absent, Carson concludes.
A paper from the San Francisco Fed (helpfully forwarded by Torsten Slok, Apollo Global Management’s chief economist) finds that an alternative measure of unemployment—which adjusts for those out of work temporarily but likely to be called back or find jobs quickly—is a more accurate short-term predictor of a downturn than the yield curve. The authors’ conclusion: “The jobless rate doesn’t currently signal an impending recession.”
Finally, bears on the economy point to the Fed’s shrinkage of its balance sheet and the corresponding decline in the money supply—portents of past economic downturns. Evercore ISI points out, however, that those measures remain elevated after their huge pandemic-related increases. The M2 money stock is over $21 trillion, versus $15 trillion before Covid-19 struck.
Despite 2022’s drops in stock, bond, and home prices, Evercore ISI says consumers’ net worth is $145 trillion, up from a prepandemic $115 trillion. And even with the widely advertised decline in average house prices, the Case-Shiller measure of about $300,000 is still way above the $230,000 prepandemic level.
For all the predictions of a recession in 2023, monetary, credit, wealth, and labor measures say otherwise. If they’re right, the Fed is likely to deliver on the rate hikes it projects, rather than the rate cuts bulls hope for.