A recession is still likely. Here are 6 reasons why

Inflation has trended lower this summer, jobs remain plentiful and consumers have continued to spend, bolstering confidence – especially from the Federal Reserve – that the world’s largest economy will avoid recession.

A last minute deal To avoid a government shutdown, an imminent risk is postponed to the future. But a massive auto strike, the resumption of student loan repayments and the possibility of another government shutdown after a stopgap spending deal lapses could easily shave a percentage point off GDP growth in the fourth quarter.

Combined with other powerful forces affecting the economy — from dwindling pandemic savings to soaring interest rates and now oil prices — the combined effect could be enough to tip the U.S. into recession as early as this year.

Here are six reasons why a recession remains the base case forecast for Bloomberg Economics. They range from the wiring of the human brain and the mechanics of monetary policy, to strikes, rising oil prices and the looming credit crunch – not to mention the end of Taylor Swift’s tour.

The bottom line: History and data suggest the consensus is a little too complacent — as has been the case before every U.S. recession over the past four decades.

Calls for a soft landing always precede a recession…

“The most likely outcome is that the economy will move toward a soft landing,” then-San Francisco Fed President Janet Yellen said in October 2007, two months before the Great Recession began. Yellen is not alone in her optimism. Calls for soft landings peak just before hard landings arrive, with alarming regularity.

Why do economists find it so difficult to predict recessions? One reason is the way forecasting works. It usually assumes that what happens next in the economy will be some extension of what has already happened – in the jargon, a linear process. But recessions are non-linear events. The human mind is not good at thinking about them.

This is an example of looking at the unemployment rate, a key measure of the health of the economy. The Federal Reserve’s latest forecast is that the unemployment rate will rise from 3.8% in 2023 to 4.1% in 2024. This is a continuation of the current trend and the United States will emerge from recession.

But what if there is a break in the trend—the sudden shift that occurs when an economy goes into recession? Using a model that takes these nonlinearities into account, Bloomberg Economics predicts not only the most likely path of the unemployment rate, but also the distribution of risk around that path.

The key takeaway is that risks are heavily tilted towards rising unemployment.

…The Fed’s interest rate hikes will have serious consequences

Milton Friedman famously said, “Monetary policy operates with long and variable lags.” One subtlety here is that “variables” can refer to more than just one recession versus another. The difference can also refer to different parts of the economy within a single cycle.

Soft landing optimists point out that the stock market has performed well this year, the manufacturing industry is bottoming out and the real estate market is accelerating again. The problem is, these are the areas with the shortest lag time between rate hikes and real-world impact.

For parts of the economy that are critical to the recession – especially the labor market – the lag time is longer, typically 18 to 24 months.

That means the full force of the Fed’s rate hikes – 525 basis points since the beginning of 2022 – won’t be felt until the end of this year or early 2024. When that happens, it will provide new impetus for the stock and housing market declines. It’s too early to say the economy has weathered the storm.

The Fed’s rate hikes may not be over yet. In their latest forecasts, central bankers expect to raise interest rates again.

Economic downturn lurks in forecast…

Against the backdrop of monetary tightening, it’s no surprise that some indicators are already sounding alarm bells. Bloomberg Economics takes a closer look at measures of particular importance to leading academics who will formally declare whether the U.S. is in recession.

The National Bureau of Economic Research typically doesn’t make this determination until several months after a recession actually begins. But the National Bureau of Economic Research’s Recession Dates Committee identified six indicators that will have a significant impact on policymaking, including measures of income, employment, consumer spending and factory output.

Using consensus forecasts from these key figures, Bloomberg Economics built a model to simulate the committee’s decision-making process in real time. It matches past calls very well. Outlook for the future: Sometime next year, the NBER will most likely declare a U.S. recession to begin in the final months of 2023.

In short: If you look at the indicators that matter most to U.S. recession policymakers — and where most analysts think they are headed — a recession is already brewing.

…and that was before these shocks happened

This assessment is largely based on forecasts from the past few weeks – which may not capture some of the new threats that could derail the economy. Among them:

• automatic strike: The United Auto Workers union called the three major U.S. auto companies to go on strike, marking the first time they have been targeted simultaneously. The strike expanded to about 25,000 workers on Friday. The industry’s long supply chains mean shutdowns could have a huge impact. In 1998, 9,200 General Motors workers went on strike for 54 days, resulting in a loss of 150,000 jobs.
• Student Bill: Millions of Americans will start collecting student loans again this month after a 3.5-year pandemic freeze. Resuming payments could shave another 0.2-0.3% off annualized growth in the fourth quarter.
• oil spike: A surge in crude oil prices — hitting every household’s wallet — is one of the few truly reliable indicators that a recession is coming. Oil prices have risen nearly $25 from summer lows to over $95 a barrel.
• Yield Curve: September’s sell-off pushed the 10-year Treasury yield to a 16-year high of 4.6%. Longer periods of higher borrowing costs have caused stocks to fall. They could also put the housing recovery at risk and discourage business investment.
• Global economic recession: The rest of the world could drag the United States down. China, the second largest economy, is mired in a real estate crisis. In the euro zone, lending is contracting faster than at the nadir of the sovereign debt crisis, suggesting that already stagnant growth will slow further.
• government shutdown:A 45 days offer Keeping the government open from October to November raises the risk that, at this point, it could end up doing more damage to fourth-quarter GDP numbers. Bloomberg Economics estimates that the shutdown will reduce annualized GDP growth by about 0.2 percentage points each week, with most, but not all, of it recovering once the government reopens.

Beyoncé can only do so much…

Central to the soft landing argument is the strength of household spending. Unfortunately, history shows that this is not a good guide to whether a recession is imminent—U.S. consumers typically keep buying until the brink of a recession.

What’s more, the extra savings Americans accrued through stimulus checks and lockdowns during the pandemic are being depleted. There is debate over how quickly, but the San Francisco Fed calculated they were all gone by the end of September. Bloomberg calculations show that the poorest 80% of the population now have less cash on hand than before the coronavirus outbreak.

Last summer, Americans splurged on popular entertainment shows.Barbie and Oppenheimer movies and Beyoncé and Taylor Swift concerts were all sold out, he added. A staggering $8.5 billion GDP in the third quarter. This looks like a last hurrah. As savings run out and concerts end, the strong drive to spend has been replaced by a void.

A glimpse into what’s ahead: Credit card delinquency rates are rising sharply, especially among younger Americans, and parts of the auto loan market are getting bad.

…the credit crunch has just begun

The Fed’s Survey of Senior Bank Credit Officers, known as SLOOS, does have a good track record of predicting recessions.

About half of large and medium-sized banks are implementing tougher standards on commercial and industrial lending, latest data shows. Outside of the pandemic, this is the highest ratio since the 2008 financial crisis. The impact is expected to be felt in the fourth quarter of the year – when businesses can’t borrow easily, which typically leads to weaker investment and hiring.

Defense

Of course, optimists can also gather some strong evidence.

Vacancies: A key part of a hard landing is based on the idea that the labor market is overheating and that cooling it requires rising unemployment. But maybe there’s a less painful path? This is the argument made by Fed Governor Chris Waller and staff economist Andrew Figura in the summer of 2022: Even if unemployment remains low, a decline in job openings could It would dampen enthusiasm for wage growth. So far, the data is consistent with their argument.

productive forces: In the late 1990s, rapid productivity gains due to the IT revolution allowed the economy to outperform the market without the need for the Federal Reserve to slam on the brakes. Fast forward to 2023, and the creative destruction unleashed by the pandemic, coupled with the potential of artificial intelligence and other new technologies, could mean a new surge in productivity — keeping economic growth and inflation under control.

Bidenomics: President Joe Biden’s support for industrial policy — he has been providing subsidies to the electric vehicle and semiconductor industries — has not won him any friends among free-market fundamentalists. But it triggered higher business investment, another factor keeping the economy growing.

moist squib: Some expected impacts may be too small to move the dial. If the auto strike ends quickly, the government remains open, and student loan repayments are at the low end of our estimates — and the Biden administration is offering new programs to cushion the impact — the drag on fourth-quarter GDP could end up being a rounding error. Our recession forecast does not depend on all of these shocks, but if none occur, the chances decline.

Pride is a leading indicator of failure

For economists, the past few years have taught them a lesson in humility. Faced with the huge impact of the new crown epidemic and the war in Ukraine, the forecasting models that performed well during the economic boom have completely failed.

All of this gives us good reason to proceed with caution. A soft landing is still possible. But is this the most likely outcome? As the U.S. faces the combined effects of rising interest rates from the Fed, auto strikes, student loan repayments, rising oil prices and a slowing global economy, we think not.

— With assistance from Katia Dmitrieva, Stuart Paul, Andrej Sokol, Alexandre Tanzi, Rich Miller and Cedric Sam