The recession watch for the U.S. economy has been going on about a year and a half now, and, if current indicators are sign, it likely has a ways to go. Wall Street has been forecasting an economic contraction since the early part of 2022, the result of confluence of factors. To name a few: Two consecutive quarters of negative growth to start last year, a Federal Reserve rate-hiking campaign the likes of which often coincide with recessions, and multiple market and data signs that historically have been extremely reliable indicators that trouble is coming. Yet, still no recession. So what gives? “Your camel has a lot of straws on its back. Eventually, it’s going to be too much,” said Joseph LaVorgna, a top economic advisor during the Trump administration and now chief economist at SMBC Nikko Securities America. “Now, when that is, it’s hard to say.” LaVorgna is in the camp that says it will be difficult if not impossible for the U.S. to avoid at least a modest period of negative growth in the second half. Among the most common factors cited are those 10 rate increases from the Fed since March 2022 and the lagged impact they’re expected to have on the economy. Other risk factors include low confidence readings from small business, a manufacturing contraction and leading indicators all consistent with recessions. ‘They will turn very quickly’ Even the uncanny strength in the labor market is being seen as a weak point in that many economists think it can’t continue and is a lagging indicator in any event. Indeed, job growth was stunning in the first half of the year — an addition of 1.57 million workers in nonfarm payrolls just through May and an unemployment rate still at just 3.7%. There were still 5 million more jobs than available workers through April, indicating considerable slack in the labor market, though many economists think that dynamic is ready to change. “My guess is when things turn, they will turn very quickly,” LaVorgna said. “The only way we won’t have a deep recession is if the Fed has the courage to ease very quickly.” To a person, though, Fed officials don’t seem to have any appetite for easier monetary policy. At the most recent meeting of the rate-setting Federal Open Market Committee, every member indicated in their economic outlooks that the central bank’s benchmark rate would stay at least where it is now, with most expecting two quarter-point moves higher before the end of the year. Yet so far, the markets and economy have held up well. GDP unexpectedly rose at a 2% annualized pace in the first quarter and, according to the Atlanta Fed’s data tracker , is on pace to increase another 2.2% in the second quarter. For its part, the stock market has soared. That’s hardly the stuff recessions are made of. The case for no recession “The economy has a fighting chance, a better than even chance, of skirting a full-blown economic downturn,” said Mark Zandi, chief economist at Moody’s Analytics. “The second half will be difficult. The economy will be basically treading water, not going anywhere fast, but that’s exactly what the Fed wants.” The Fed has been targeting its rate hikes squarely at a jobs market in which average hourly earnings have risen 4.3% from a year ago — a solid pace but one that nevertheless has not kept up with core inflation and is above what policymakers consider a sustainable level. If, as Zandi suggests, that part of the economy eases up, it likely will be both cause and effect of a further easing that bring prices back closer to the Fed’s long-term 2% inflation target. If it doesn’t, though, that will keep the Fed in a tightening stance and raise the chances of a more severe slowdown. Part of the Fed’s policymaking formula is working on expectations. If consumers and businesses think inflation is rising, they’ll adjust behavior accordingly. By that measure, things are going well. The June consumer sentiment survey from the University of Michigan showed that respondents expect inflation over the next year to run at a 3.3% pace, the lowest outlook in more than two years. “It’s important to make sure that inflation expectations remain pinned to the ground, because that just makes it a lot easier to get inflation back to target,” Zandi said. If market reaction is any indication, investors widely expect the Fed to engineer a soft landing for the economy, without the need for excessive rate hikes that will slow things down too much. The S & P 500 posted a gaudy return of nearly 16% for the first half after suffering through a difficult 2022 punctuated by extreme uncertainty about recession risks and Fed policy. Even a brief banking crisis in March hasn’t knocked the market off its pins. And if history is any guide, the strength that has marked the first half of the year likely will carry over into the second half. In years when the index gained more than 10% in the first half, the second half usually sees double the normal second-half return, according to CFRA. However, the firm has just a 4,575 year-end target for the S & P 500, implying an advance of about 2.8% from Friday’s close. Its 12-month target of 4,820 equates to a roughly 8% gain from current levels. “Even though there remains the possibility of elevated volatility in Q3, should the Fed hike rates in July and continue to pressure GDP growth and employment trends, CFRA sees investors looking beyond the near-term weakness and focusing on projected improvements in GDP growth and earnings increases in 2024,” Sam Stovall, the firm’s chief investment strategist, said in a recent client note. The bond market’s black cloud Other signs persist that a recession threat looms. While the equity market is not signaling recession, the bond market very much is. The yield curve inversions between the 10-year Treasury and both the three-month and two-year note are around historic highs. Both relationships have perfect records in predicting recessions, generally six months to a year in the future. What they don’t predict, though, is the depth of those recessions. Even with all the ominous signs out there, virtually no economists expect a steep downturn on the horizon. Ian Shepherdson, chief economist at Pantheon Macroeconomics, said he sees a “modest decline in GDP” through the rest of the year, coming with receding inflation at a pace even faster than the Fed anticipates. “A deep recession is unlikely, given that both households and businesses are still sitting on excess savings accumulated during the pandemic,” Shepherdson wrote in his second-half preview. He noted, though, that the cash cushion is dwindling and now “in the hands of higher income households and large corporations, with relatively low marginal propensities to consume and invest.” All those things take time to make their way through to tangible impacts, much the same as rate hikes. That makes the timing increasingly hard to figure on when — or if — the economy finally falls into a recession. “The recession is still a threat,” said Zandi, the Moody’s economist. “But it feels like a receding one, and certainly not something that’s going to happen in the next few months.”
