One of the dominant narratives this time last year was that a US recession was highly likely during 2023, with consequent negative impacts on the global economy and financial markets. This view was driven by the rapid rise in inflation and aggressive hiking of interest rates by the US Federal Reserve.
We had a different view, believing a soft landing, characterised by slowing growth but avoiding a ‘broad-based weakening’, was more likely. This is because we anticipated that inflation would decline without the need to necessarily force the economy into recession, as was the case in previous inflation episodes. The significant excess job openings could allow wage inflation to be controlled through the destruction of job openings rather than actual jobs.
Fortunately, this turned out to be accurate and the US economy has been stronger than expected this year. Real GDP growth more than doubled in the third quarter this year to 4.9% at an annual rate¹, picking up briskly from a 2.1% gain in the second quarter. Company earnings have also improved.
Equity markets have accordingly been stronger than expected, as last year’s valuation reset was expected to give way to a wave of falling earnings and profitability, thereby extending market declines.
However, the risk of a recession in 2024 still exists, but the absence of significant imbalances should prevent a substantial or broad-based downturn. US employment is a key indicator to watch.
Globally, while inflation has cooled markedly, where it will go from here is still at the forefront of everyone’s minds, with global central bank policy responses to it being closely monitored.
The view that policy rates globally (except in Japan) have peaked, seems to have risen to the top, with many believing rates will remain higher for longer. The market volatility over the last few months has largely been driven by this dynamic.
The implications of this for future economic growth, especially in the US, is fiercely debated. This has made itself felt in the US Treasury Bond market, where the yield on the 10y bond rose to almost 5% last month before reducing to the current level around 4.5%.
When designating a recession, the National Bureau of Economic Research in the US focuses on six measures, namely:
• Real personal income, less transfers (social security payments, food stamps, social assistance, and the lottery)
• Nonfarm payroll employment
• Household survey employment (civilian and non-institutional)
• Real consumer spending
• Real wholesale plus retail sales
• Industrial production
To date, most of these indicators are in positive territory, a good sign that the economy is not, in fact, in a recession. Employment is strong, consumer spending is somewhat neutral, and there has been solid growth in both wholesale and retail sales. Industrial production is strong. As these
indicators are only measured retrospectively (and in some cases revised higher or lower), however, they are not forecasting what might happen and, in fact, recessions are only designated retrospectively.
We believe that if there is a recession in the US it is likely to be mild. The transfer mechanism from a mild to a bad recession is generally through the banking system. When there is excess leverage in the banking system as a whole or a particular part of the economy, as occurred with sub-prime property lending during the Global Financial Crisis (GFC), this can cause systemic issues in the financial system and potentially trigger a run on the banks. US banks overall are much better capitalised than they were in the period leading up to the GFC, however, there were still issues with some of the regional banks earlier this year, forcing the Treasury and the Fed to step in quickly to prevent something more systemic from developing.
The concern now is mainly around commercial real estate, and particularly office space, but it’s a much smaller portion of the market and to be honest, the levels of leverage are nothing like they were in the residential real estate market before the financial crisis.
¹Gross Domestic Product | U.S. Bureau of Economic Analysis (BEA)