Is a Recession Coming in 2022 or 2023?

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Commentary 

Many believe that by year-end the United States will be in a recession. On March 31 both the 2-year and 10-year Treasury yields inverted, which is typically a signal that a recession looms ahead. While an inverted Treasury yield certainly creates a large ripple effect amongst economy watchers, the vast amount of money printed over the past two years is actually far worse than an inverted yield curve. Furthermore, a number of S&P 500 stocks just concluded their worst quarter ever, and technology stocks lost close to $2 trillion in market valuation.

Consumer Price Index for All Urban Consumers (2004–2022). (Chart by Chadwick Hagan)

The mix of COVID-19 related stimulus and an increase in the money supply have sent a shock to the United States economy. Inflation alone stifles growth, but with rising commodity prices, supply and demand problems, and the Russian-Ukrainian war, you have the potential for a proper disaster on your hands, let alone a recession.

Inflation is already well out of hand, hitting 7 percent in some sectors. The Federal Reserve Bank of San Francisco admitted the measure to combat COVID created more inflation than the Fed could handle, stating in a March 28 release: “Estimates suggest that fiscal support measures designed to counteract the severity of the pandemic’s economic effect may have contributed to this divergence by raising inflation about 3 percentage points by the end of 2021.”

Bill Dudley, an economist and former president of the Federal Reserve Bank of New York feels that a recession is inevitable, writing recently in Bloomberg Opinion: “The current situation is very different. Consider the starting points: The unemployment rate is much lower (at 3.8 percent), and inflation is far above the Fed’s 2 percent target. To create sufficient economic slack to restrain inflation, the Fed will have to tighten enough to push the unemployment rate higher. Which leads us to the key point: The Fed has never achieved a soft landing when it has had to push up unemployment significantly. This is memorialized in the Sahm Rule, which holds that a recession is inevitable when the 3-month moving average of the unemployment rate increases by 0.5 percentage point or more. Worse, full-blown recessions have always been accompanied by much larger increases: specifically, over the past 75 years, no less than 2 percentage points.”

The Sahm Rule signals the start of a recession when the three-month moving average of the national unemployment rate increases by 0.50 percentage points from its low over the previous 12 months. Regardless of a major or minor recession, it is becoming a steady rule that readings of 0.5 or above indicate a recession.

However, some disagree. Aneta Markowski, chief economist for U.S. investment bank Jefferies stated in a letter to family office clients: “Bottom line, businesses are currently facing excess demand, low inventories, and a lot of pricing power. This creates a strong incentive to invest and to hire. And, with historically high margins and a big pile of cash on corporate balance sheets, they certainly have the means to finance further expansion. This does not look like a late-cycle economy. It looks more like a mid-cycle economy with more room to run. Our subjective recession probabilities are -5 percent for this year, -10–15 percent for 2022, -30 percent for 2024, and close to 50/50 for 2025. It would take a very large exogenous shock to compress that timeline.”

Lisa Shalett, chief investment officer for Wealth Management at Morgan Stanley feels very much the same. She says we are far from calling a U.S. recession, and cites a few reasons why we are far from a recession. In a letter recently published by Morgan Stanley she said, “of all the kinds of inflation, commodity-based increases tend to be the most self-curing sort, and thus temporary. Usually, higher prices rapidly lead to greater production, which is often simultaneously met with lower demand.”

Regardless, investors are worried. An inverted yield curve means investors are more worried about the immediate future than the longer term. While this does not mean that a recession is around the corner or that a recession is even happening for that matter, what it does mean is that the professional investor class is worried.

Furthermore, America’s economy is driven by sentiment and confidence. Small to medium-sized business owners hold off on investment into enterprises when they have low confidence in the economy. This creates a domino effect. When business owners and investors have low confidence in the short term, less money is deployed into investments and enterprises, and economic growth stalls.

It is worth noting that the National Bureau of Economic Research (NBER) considers a recession to be “a significant decline in economic activity spread across the market, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.”

Simply put a recession is a reduction in economic activity over a period of time. Inflation alone can cause a recession. Any more headwinds could be disastrous, including policy hiccups while the Federal Reserve raises rates and simultaneously tries to contain inflation.

Instead of fiscal austerity or price controls maybe we should do away with tariffs and unnecessary taxes on certain items, therefore making them cheaper. After all, as prices rise faster than wages increase, buying and spending grind to a halt.