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The Fed no longer see a recession in our future, just a nice gentle slowdown. There's still a narrow path to a soft landing. BlackRock is even entertaining the possibility of a 'full employment recession'.
If we're taking the temperature of the marketplace, things are looking pretty good.
Q2 US GDP came in higher than expected. Durable goods orders rose way above expectations, commodities are recovering as the US economy remains resilient, China stimulates and most developed economies are at full employment...
Looking around, it's fair to say there won't be a recession right now. Maybe not even this year... But no recession at all...?
First up, that quote in full.
Powell July 2023: "So the staff now has a noticeable slowdown in growth starting later this year in the forecast, but given the resilience of the economy recently, they are no longer forecasting a recession"
Did you spot it?
That giant red flag of recency bias...
Or if you're feeling a little less generous, the white flag of surrender.
Fed forecasts have been terrible, and now "given the resilience of the economy" (past tense), they're updating their (forward looking) forecast.
Recency bias - a type of cognitive bias that causes us to assume that future events will resemble recent experiences
The Fed staff are very late to the 'no recession' party. Back in November last year, we asked this question... 👇
... Bullard says rates will need to climb to 5% at a minimum to be considered restrictive. Rates aren’t even at this restrictive level yet, and monetary policy is known to work with long and variable lags.
On this basis, the idea that the US economy could keep growing in 2023 isn’t so outlandish. If that economic growth leads to more inflation, especially in energy, could the Fed be forced to push rates even further into Bullard’s zone?
We’re told a recession will be needed to kill inflation. But maybe that recession isn’t as imminent, or shallow, as markets are hoping.
With the benefit of hindsight, we can certainly say that recession wasn't imminent. Now the academics aren't even assuming it'll be a shallow recession. There just... Won't be one. For uh, reasons.
BlackRock's idea of the lesser-spotted “full employment recession” is a novel one too...
Economic relationships investors have relied upon could break down in the new regime. The shrinking supply of workers in several major economies due to aging means a low unemployment rate is no longer a sign of the cyclical health of the economy.
This time is different
Broad worker shortages could create incentives for companies to hold onto workers, even if sales decline, for fear of not being able to hire them back. This poses the unusual possibility of “full employment recessions” in the U.S. and Europe.
That could take a bigger toll on corporate profit margins than in the past as companies maintain employment, creating a tough outlook for DM equities.
I shared this back in March 👇
It's now been 16 months. Only once in the history of Fed hiking cycles has a recession started less than 19 months after the first hike.
Which is largely why this idea that a recession will be avoided just because it hasn't already happened is insane to me, especially with the historical context.
And also, this historical context from Fed veteran Esther George (also from November last year). 👇
“I’m looking at a labour market that is so tight, I don’t know how you continue to bring this level of inflation down without having some real slowing, and maybe we even have contraction in the economy to get there,”
“I would love if there was that path, and I’ve seen people paint that path…
I have not in my 40 years with the Fed seen a time of this kind of tightening that you didn’t get some painful outcomes.”
And of course, we've been here before. Fed forecasts are notoriously bad (they're far from alone) 👇
Bernanke November 2007: “We think that by the spring of early next year, as these credit problems resolve and as, we hope, the housing market begins to find a bottom ... the broader resiliency of the economy, which we are seeing in other areas outside of housing, will take control and will help the economy recover to a more reasonable growth pace,”
We know what happened next. Well, ten months later...
This isn't to suggest that we're heading for another GFC. More that the future is hard to predict, forecasts are often terrible, history suggests we're not out of the woods yet, monetary lags are looming large, and there are still a wide range of outcomes on the table.
At some point, markets will look ahead and not like what they see. For now though, everything's great.
Last years recession trade has been priced out.
Now the recession isn't happening ever.
Inflation will be back to the 2% target by 2025, Powell says.
He even mentioned that they can cut rates back to neutral as long as inflation behaves in the meantime...
Which makes no sense at all, because if the economy's ticking along nicely, inflation will probably tick higher again too, meaning policymakers won't have the confidence to cut back to neutral 'just in case'...
But that's tomorrow's problem. Eventually it will matter. But markets don't care about eventually. (We all die eventually).
Maybe the Jackson Hole Symposium: "Structural Shifts in the Global Economy" will be a catalyst. Used to cement the idea of higher for longer and focus will shift towards the implications for credit next year...
For now, everything's just about fine. Markets are seemingly happy with the known risks, which is always when they're most likely to be surprised...
Summing up, it's all good, but don't believe the 'no recession' hype. Beware the lags, watch for complacency, and take advantage of our 14 day free trial 👇
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