Recession fears have hit a fever pitch.From Wall Street’s sell-side research houses to regular American households , worries that the economy is about to go into a slump are everywhere.According to Google Trends , searches for “recession” are spiking.The phrase ” how to prepare for a recession ” has nearly tripled in search interest over the past week in the US.These household recession concerns go hand-in-hand with inflation concerns, as search interest around rising prices is also surging.
But my sense is that the recession and inflation fever is about to break.When sell-side analysts are competing to see who can make the most dire recession prediction and ordinary people are frantically Googling these topics, we’ve likely hit peak freak out.And given the recent, sharp decline in the stock market, you can be sure investors have already priced in these recession concerns.
This high level of worry likely means three things are on the horizon for the economy: cooler inflation, declining risk of recession, and the potential for the stock market to head higher.
Things look pretty good, actually What’s unusual about the recession discussion is just how divorced it is from recent economic data.The doom-and-gloom chatter has picked up at a time when the US economy continues to expand at a healthy clip, and the recent economic data are beating economists’ estimates.
Take the jobs report : nonfarm payrolls averaged monthly growth of 552,000 in the first quarter of this year compared to 627,000 in the fourth quarter of 2021 and 515,000 in the third quarter of 2019 — before the pandemic.That’s hardly consistent with a slowdown, let alone a recession.
The growth in the number of hours worked by Americans is also consistent with strong economic growth.
And what about manufacturing? The analysts and economists worried about a recession have paid plenty of attention to the decline of the ISM Manufacturing PMI, a gauge of manufacturing purchasing managers’ outlook for their business and the economy, which peaked 13 months ago .But measures of actual manufacturing are holding up, and show no signs of a slowdown.Manufacturing production has advanced at an annualized rate of 9.1% over the last three months.Averaging out the three months ending in March, factory output grew at an 5.4% annual rate in the first quarter compared to 5.6% growth in the fourth quarter of 2019.
All of this data is consistent with real GDP growth of roughly 4% to 5% — stronger than many years since the 2008 financial crisis.Not surprisingly, the Atlanta Fed’s GDPNow tracking estimate also sees the components of GDP that are based on the underlying demand from American households and businesses growing at around that level.
All the weakness dragging down overall GDP projections comes from net exports and inventory investment, the two most volatile components.But while those elements fluctuate, the private domestic demand pieces of GDP are more indicative when it comes to forecasting real GDP and employment growth for the quarter ahead.
Moreover, both Europe and China have struggled so far in 2022 due to the war on Ukraine and massive COVID-related shutdowns , respectively.I have a difficult time seeing how the economic situations in Europe and China would get significantly worse in 2023 — and there’s a good chance both regions are stronger next year.
If growth outside the US picks up, it is hard to see the US slipping into recession.The US can deal with weak growth overseas, but other regions find it hard to manage when the US is slowing.
Bottom-line: recession risks are poised to drop meaningfully Inflation has surged and it’s no wonder that people are concerned.Over the last three months, the headline consumer price index has climbed 2.7%; that is more in just three months than in any single year going back to 2009.While I am not ready to lay aside my concern on the inflation outlook, the situation is unlikely to get worse in the coming months.Inflation rates will remain elevated but won’t continue to go even higher for three key reasons.
First, a significant source of inflation pressure — used car prices — is now fading.Prices for used cars and trucks are down 4% over the past two months and measures of prices at recent wholesale auctions suggest that the declines will continue .
Importantly, as supply chain pressures ease, motor vehicle production appears to have picked up: In March, motor vehicle assemblies hit their highest level since January 2021.There’s plenty of catching up left to do but we’re clearly heading in the right direction.This may be one reason why prices for new cars have moderated in recent months too.
Second, the US dollar is getting stronger .When the dollar gets stronger, it becomes cheaper for Americans to buy products from abroad.
One-fourth of US imports come from the Euro area, the UK, and Japan; since the dollar has strengthened notably against these currencies, importers’ cash will go further when buying in goods from these countries.This should also, in turn, help drive down inflation — a standard rule of thumb is that every 10 percentage point increase in the broad dollar index shaves 0.2 percentage points off core inflation one year later.The broad dollar is up roughly 7.5% over the last year, which implies a downward pressure on inflation over the next year.
Third, inflation expectations don’t appear to be unmoored.These expectations are important because they can be a self-fulfilling prophecy .
If Americans expect prices to go higher over the next few years, they’re more willing to stomach price increases now, which allows businesses to then hike prices again down the road, and so on.While short-run inflation expectations have surged on the back of rising food and energy prices, medium and long-term inflation expectations (which are generally more predictive of inflation in the long run) have stopped moving higher.As an example, in the New York Fed’s Survey of Consumer Expectations , the median one-year ahead expected inflation rate is now at a new high, but expectations for inflation over the next three years peaked five months ago .
These factors don’t mean the US is going to get back to the Federal Reserve’s 2% inflation target anytime soon, but it’s clear the situation is not getting worse.
Good news for stocks So, in the face of seemingly unrelenting negativity, there are clearly some upsides: stronger nominal economic growth and the likelihood that future price hikes aren’t as steep.And since the stock market has mostly been fed negative news over the past few weeks, there’s good reason to think that investors have fully digested these fears.As the outlook starts to improve, that should be a positive catalyst for equity markets.Moreover, the market had already priced in numerous Fed interest rate hikes over the course of the year, so any further increase in rates won’t shock the market or send it into a downward spiral.
There are, of course, some risks.For one thing, labor markets will continue tightening, putting upward pressure on wages.Eventually, this will put pressure on inflation at a time when price growth will still be a fair bit above the Fed’s longer-run objective.
It’s almost like a person getting in shape: “I’ve dropped almost 30 pounds over the last 12 months, but my cholesterol is still over 250!” Much like the journey of this theoretical dieter, the Fed’s journey is also not yet complete.If these inflation pressures keep the overall rate higher than the Fed wants, even as prices for some goods come down, this could force the Fed to get even more aggressive down the road — which would be a surprise for investors and probably drive stocks lower.
But for now, it seems like things are getting better — despite what you may have heard.Inflation is not surging away from the Fed.Underlying demand is accelerating.Put differently, the composition of America’s nominal economic growth is improving: instead of growth coming just from rising prices, we’re also seeing a bit more growth from moving a larger quantity of goods.That’s welcome news for the stock market and for the anxiety of everyday Americans..