Whatever happened to the US recession?

We see recession as being delayed rather than dodged.

The US continued to grow at the end of last year and appears to have started 2023 on a firm note. Economists are now pushing out or cancelling a US recession which was expected only a few weeks ago. So, why has the US defied the sceptics and remained resilient in the face of significant monetary tightening?

The failure of Silicon Valley Bank (SVB) has complicated the picture and will result in some tightening of financial conditions and caution on the part of investors. Our view is that this will dampen growth, but at this stage does not appear to be sufficiently systemic to cause a more general credit crunch and a recession. The situation is fluid, as the Federal Reserve (Fed) raised the key Fed funds rate at its latest meeting by 25 basis points (bps) to 5% on its upper bound as expected.

Consequently, in this note we take a broader look at the factors behind the recent US resilience. Our long held view had been that the shock delivered to the economy over the past year from higher energy prices, alongside rising wage costs and interest payments, would weaken demand and cause the corporate sector to retrench.

There have been some signs of this in sectors such as technology, which has been cutting jobs after expanding rapidly during the pandemic lockdowns. A process which may accelerate in the wake of the failure of SVB. However, we have not seen widespread layoffs across the economy, or much of an increase in unemployment which remains close to record lows.

Companies continue to report shortages of workers and job openings are buoyant with nearly two vacancies for every unemployed person. The labour market has not cracked as expected.

Companies have passed on rising costs to maintain their margins

Listening to companies in the recent earnings season provides an explanation as to how they have withstood the shock to their cost base. It is clear that there is still pricing power with firms able to pass on higher costs into prices such that the squeeze on profit margins has yet to materialise. This is borne out by the macro-economic data which shows prices rising faster than unit wage costs in the business sector. Profit margins have been maintained and cashflow continues to exceed expenditure in the corporate sector (chart 1).

Against this backdrop firms have not been under financial pressure to restructure and cut jobs. As a consequence inflation is still a problem as costs have been passed through into consumer prices.

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