Michelle ThompsonIndicators were pointing towards a recession in 2023. A year ago, persistent high inflation forced the Federal Reserve to continue raising interest rates. The S&P 500 was in the midst of a bear market, layoffs, particularly in the tech sector, were accumulating as companies sought to reduce expenses. Additionally, the Philadelphia Phillies reaching the World Series, historically considered a negative sign for the economy due to previous recessions coinciding with the team’s victories, added to the gloomy outlook.
However, the economy seemed to defy expectations as the Phillies ultimately lost to the Houston Astros, and a recession did not materialize. The reasons for this turn of events were less connected to baseball and more attributed to sound policies and a dose of good fortune.
Nonetheless, it’s essential to heed the standard investment disclaimer that past performance does not guarantee future results.
Arguments suggesting the likelihood of an economic downturn in 2024.
The potential for a recession has increased since the Federal Reserve initiated its tightening cycle in March 2022, according to Federal Reserve Chair Jerome Powell’s comments in December. Despite asserting that there is currently little evidence to suggest an ongoing recession, Powell emphasized that even during periods of apparent economic strength, the risk of a recession in the upcoming year remains due to unforeseen economic shocks, such as a global pandemic.
Economists, considering present conditions, believe that unless unexpected events occur, there is still a chance of a recession in the coming year. Kathy Bostjancic, the chief economist at Nationwide Mutual, points to specific metrics, such as employment in the private services sector excluding health and education, as indicators of economic health. Sectors like transportation and leisure and hospitality within private services are more cyclical and prone to economic downturns.
November 2022 data showed 92,000 monthly hires in the private services sector excluding health and education, but the November 2023 report indicates a significant drop to 22,000 new hires in the same sector. Despite overall solid job growth in the past year, Bostjancic remains cautious, assigning a 65% chance of a mild recession in 2024. She predicts the unemployment rate will rise to 5% by the third quarter, almost a percentage point higher than the Federal Reserve’s median projection for 2024. Bostjancic highlights that the income decline resulting from increased unemployment could lead to reduced consumer spending, contributing to a potential recession. Unlike previous years, consumers lack additional resources, having depleted savings accumulated during the pandemic.
As we approach 2024, the economy seems relatively robust, and inflation is trending closer to the Federal Reserve’s target. However, the absence of a recession is not guaranteed.
The risk of a recession is also associated with actions taken by the Federal Reserve. The current elevated interest rates, implemented by the central bank to curb inflation and bring it closer to the 2% target, pose a potential challenge. If inflation continues to decrease, and the Fed delays cutting interest rates, it may hinder economic growth, as noted by Louise Sheiner, a senior fellow at the Brookings Institution and the policy director for the Hutchins Center on Fiscal and Monetary Policy.
Determining the optimal time to cut interest rates becomes complex for the Fed. The prior actions of the central bank might already be slowing the economy to achieve the inflation target, even if this effect is not immediately apparent in the data. Failing to adjust interest rates could lead to an unintended overshooting, potentially causing a recession.
Conversely, there is also a risk that inflation becomes more challenging to combat. To uphold the commitment to lowering inflation to 2%, the Fed might need to orchestrate a deliberate slowdown, potentially involving keeping rates higher for a more extended period than investors currently expect or even considering rate hikes.
Arguments supporting the idea of another year without a recession
It is not entirely implausible for the Federal Reserve to achieve a soft landing, referring to a situation where inflation moderates without a significant increase in unemployment. In the past 60 years, out of the 11 cycles of interest rate increases aimed at curbing inflation, this outcome has occurred only a few times—specifically in 1964, 1984, and 1994. However, the historical rarity of such instances does not rule out the possibility of it happening again in the future.
David Mericle, the chief US economist at Goldman Sachs, holds the view that a soft landing is achievable. In a November note, he expressed confidence that the challenging phase of the inflation battle is behind us, stating that the conditions for inflation to return to the target are in place, and the significant impacts of monetary and fiscal tightening are in the past.
Despite concerns about a recession in the previous year, Mericle does not perceive any notably heightened risks currently. With the unemployment rate at historically low levels and numerous job opportunities available, he finds it unlikely for a sudden deterioration in the labor market. Mericle’s team assigns only a 15% chance of a recession in the next 12 months, considering it as the historical unconditional average, while acknowledging that unforeseen shocks to the economy could be a potential trigger for a recession.
