How does a recession happen?
“Slowly and then all at once.”
Economists are increasingly confident that the economy will avoid a recession. This is due to the strength of the work and data. Even Jerome Powell, in his recent report, took note of the strength of the data. This is:
“Additional evidence of persistently above-trend growth, or that labor market tightness is no longer easing, could put further inflation gains at risk and could justify further tightening of monetary policy.
In any case, Inflation remains too high and a few months of good data are just the beginning. than will be necessary to generate confidence that inflation is falling sustainably toward our goal.‘”
Despite substantially tighter monetary policy, strong employment and retail sales dashed expectations of a recessionary recession in 2022. However, this was not surprising. This was a topic we wrote about several times, including Michael Lebowitz.
“The economy has moved forward, ignoring higher interest rates and constant calls for a recession. Credit goes to ‘We the People’, the citizens of the US. A shout out also to Uncle Sam for showering us with trillions of dollars of stimulus during the pandemic to boost consumption.
Understanding why the economy has done so well is easy. A massive stimulus boosted consumption. The difficult task ahead is to forecast the extent to which the remnants of stimulus and other forms of financial relief will continue to strengthen personal consumption and boost economic activity.”
Given that personal consumption consistently accounts for more than two-thirds of economic activity, it is not surprising that when money is sent directly to households, the result is both increased consumption and higher inflation. Three years after the economic shutdown caused by the pandemic, monetary liquidity remains very high as a percentage of the . That stimulus-driven demand surge led to higher job growth, higher wages, and, as noted, higher inflation.
Like a large bonfire, that increase in the money supply that ignited economic activity takes time to burn. “consume.” As that excess liquidity expires, the rate of economic growth and ultimately inflationary pressures will reverse.
As such, what we currently see in employment and retail sales data does not suggest a stronger economic growth rate in the future. As we will see, it is just a reflection of the decline in economic activity driven by the last remnants of financial stimulus.
Driving by the rearview mirror
As noted in that blog, the economic data presents a reasonably significant delay. This is because the data is subject to extensive negative revisions in the future.
“Each of the above dates shows the growth rate of the economy. immediately before the start of a recession. You’ll notice in the table that in 7 of the last 10 recessions, real GDP growth was 2% or more. In other words, according to the media, there was NO sign of a recession. But the next month one started.”
NBER GDP peak versus recession
This is an even more critical issue when you understand how the Federal Reserve manages monetary policy in the “rearview mirror.” Current real-time economic data suggests that the economy is rapidly moving from an economic slowdown to a recession. The signs are becoming more evident from inverted yield curves to the six-month rate of change of the Leading Economic Index.
However, while these signals generally precede economic recessions, employment and retail sales data lag behind. For example, if we compare real GDP, we see that low unemployment, a sign of a strong labor market, always precedes the beginnings of a recession.
Dating in recession occurs with a delay
Low unemployment precedes recessions because we are facing “reviewed” data. As noted last Friday, it is often 6 to 12 months later that the National Bureau of Economic Research (NBER) dates the start of a recession. This is because the data must be reviewed before determining the official date of the start of the recession.
“The following table shows the with two points. The blue dots are when the recession started. The yellow triangle is the date the NBER dated the start of the recession. In 9 out of 10 cases, the S&P 500 peaked and fell before recognizing a recession.“
Do you see the problem of “no recession” call of economists? The same problem applies to retail sales data. Economists believe recent strong retail sales data negates the recession.
“Despite a low savings rate, sluggish demographics, depressed confidence, a paralyzed housing market, rising interest costs and growing credit problems, we estimate that American consumers increased their inflation-adjusted spending by more than 4% in the third quarter.” – David Kelly, chief global strategist at JPMorgan Asset Management
In nominal terms, it’s pretty clear that retail sales have increased recently. However, as shown, spikes in retail spending, like employment data, are often seen just before the start of a recession. As such, the recent strength in retail sales data gives us little to no indication of the risk of recession ahead.
The same goes for inflation-adjusted retail sales data. Before the last three recessions, retail spending was strong just before the recession. Once again, current actual retail sales data does not indicate that a recession is being avoided.
We should pay attention to the gap between retail sales and employment. The current gap is probably unsustainable because the income needed to consume comes from employment. As expected, that gap will be rectified with a recessionary slowdown in the economy.
The challenge for the Federal Reserve and traditional economists is that “Driving by the rearview mirror” has repeatedly had disappointing results.
The great risk of the Federal Reserve
Here is the risk. Jerome Powell and other Fed members are directing changes to monetary policy based on solid economic data. This is:
“Additional evidence of persistently above-trend growth, or that labor market tightness is no longer easing, could put further inflation gains at risk and could justify further tightening of monetary policy.“
However, that strong data is subject to strong negative revisions in the future. This puts the Federal Reserve at risk of exacerbating an economic contraction if it maintains monetary policy “too tight for too long.” Historically, when the Federal Reserve raises rates, there eventually comes a breaking point at which unemployment rates skyrocket. This is because data is solid until it is not.
This breaking point occurs because the economy in real time adjusts to changes in monetary policy. However, data such as employment and inflation may be delayed by several months.
Given this lag effect, the Fed will continue to believe that it must maintain restrictive monetary policies.monetary politics” to slow economic demand and bring inflation back to its target. However, the real impact on consumers and economic activity is not timely reflected in the CPI. This creates the likelihood that the Federal Reserve will overtighten monetary policy and turn an economic slowdown into a more severe economic contraction.
Of course, this is what history tells us will happen.
The money supply also tells us the same thing. , Inflation was due to supply restriction due to economic shutdown and increased demand for “stimulus” checks. The huge increase in the M2 money supply has been reversed.
Given the lag in changes in money supply, retail sales and employment data, the Fed’s risk “breaking something” is still high. While economic data may appear to suggest a “no recession” In this scenario, the problem of looking back leaves everyone vulnerable to a head-on collision with what lies ahead.
That is the risk we face now.