While the market is anticipating some Goldilocks outlook for the U.S. economy (probably for some other advanced economies as well), some hedge fund veterans warn of the hard landing risks ahead, which could be realized as soon as in the upcoming quarter.
As argued here previously, recession can happen all of a sudden; in fact, it did in all previous times throughout history. The mechanism for such sudden collapse is due to the complicated network inter-relationships among various sectors. If one starts to fall, it will drive a chain reaction, pulling all others.
If one looks at a typical kind of economic model like the Fed model (used by the Federal Reserve in projection), one will see a complicated set of linkages among all variables. In fact, in the then general setup, such as the Dynamic Stochastic General Equilibrium (DSGE), the household, firm, agent (bank), fiscal, and monetary sectors are all bundled together by way of tens of equations linking probably over a hundred economic variables (quantities and prices) of different markets. One can imagine if any moves, such a butterfly effect transmits to all others.
This time is different. Although there is nothing new under the sun, as the old saying goes, there is still something new in any new day. The difference this time is that certain sectors, including the investment ones (if categorized along the expenditure approach) or the manufacturing ones (if categorized along the industry approach), are already in recession (contraction), while others, including the consumption (expenditure approach) or services ones (industry approach), are still in good shape.
Is the transmission link between the two sectors broken in the new era?
The answer is no. There is already a strong symptom of weakness even in the jobs market. Although non-farm payrolls are still growing on a month-over-month basis, the year-over-year growth rate has been declining for nearly seven quarters (since 3/2022), as the accompanying chart shows. Extrapolating this trend, the rate is projected to turn negative by 8/2024 (red line). Looking back at previous experience, the recession would start slightly before jobs contract. This implies 2024H1 could mark the start of a recession, at the same time the market expects a rate cut to begin.
Job growth is a significant indicator because it determines income growth and, hence, consumption growth according to the standard consumption function. Job growth is also a leading indicator of the unemployment rate because jobs are counted whenever firms plan to hire (at the stage of advertising), while the unemployment definition requires four weeks after a fire.
When will firms turn from hiring to firing? This is a subtle question because it, in turn, depends on aggregate demand. That says, supply and demand are mutually affecting each other. In fact, economic models are set up this way. This loop breaks if either side deviates from the status quo. This makes the projection of the exact timing of the recession very difficult, if not impossible.
The persistent weakness in the investment or manufacturing sectors would pose pressure to break such a loop. The critical moment is indeed very near.
