Current economic slowdown, coming recession in 2023

Economic slowdown but no recession! This message comes from the latest jobs report, data from the services sector and the Federal Reserve.

“We are not in a recession right now. We have these two quarters of negative GDP growth. To some extent, a recession is in the eyes of the beholder. With all the job growth in the first half of the year, it’s hard to say there’s a recession. With an unemployment rate stable at 3.6%, it is difficult to say that there is a recession. – James Bullard, Chairman of the St. Louis Federal Reserve

Such a statement certainly belies much of the economic consensus that two-quarters of negative economic growth constitutes a recession. As noted, the latest GDP report actually hit that metric.

Economic downturn, current economic downturn, coming recession in 2023

However, as noted, some indicators suggest the economy is slowing but not yet in recession. For example, our Institute Of Supply Management (ISM) composite survey is still expanding. With services now accounting for around 80% of the economy, economic growth is currently supported. However, the data trend is negative and supports the view of an economic slowdown.

Economic downturn, current economic downturn, coming recession in 2023

Employment also remains extremely strong. With the unemployment rate near historic lows, this confirms the claim that the recession is not underway. However, low unemployment rates historically predate the recession and will quickly reverse when a recession sets in.

Economic downturn, current economic downturn, coming recession in 2023

While there are no metrics to suggest the economy has already entered a recession, that doesn’t prevent it from happening. Many indicators suggest that individuals “feel” like the economy is in a recession, like our composite index of consumer sentiment. Historically, a recessionary environment was present when consumer confidence and expectations fell below 80.

Economic downturn, current economic downturn, coming recession in 2023

Notably, given near-term economic momentum, we could see an uptick in economic growth due to back-to-school spending in Q3 and holiday shopping in Q4.

However, I suspect that as the Fed continues its aggressive mission to fight inflationary pressures, a recession in 2023 is likely.

Economic downturn, current economic downturn, coming recession in 2023

The Fed fight

While James Bullard, and others currently running the monetary policy regime, suggest they can stifle inflation with just an economic slowdown, history suggests otherwise. That’s because the Fed bases its policy decisions on lagging economic data.

As noted previously, the Fed is basing its ability to increase on high employment rates. However, historically, the Fed raises rates to a point where “something breaks.”

Economic downturn, current economic downturn, coming recession in 2023

This breaking point occurs because the real-time economy adjusts to changes in monetary policy. However, data such as employment and inflation can take several months to catch up with the real economy.

Notably, about 40% of the CPI is the owner’s equivalent rent, which has a lag of about 3 months. As noted, if inflation slows significantly to just 2% annualized, it will take until late 2023 to return to the Fed’s target rate. Any higher growth rate keeps inflation high much longer.

Economic downturn, current economic downturn, coming recession in 2023

Given this lag effect, the Fed will continue to raise rates to slow economic demand to bring inflation back to target. However, the real impact on consumers and economic activity is not reflected in the CPI in a timely manner. This creates the likelihood that the Fed will over-tighten monetary policy, turning an economic slowdown into a more severe economic contraction.

Of course, that’s what history tells us will happen.

Economic downturn, current economic downturn, coming recession in 2023

The money supply also tells us that the Fed is likely making a mistake with its current aggressive stance on inflation. As discussed recently, inflation is the consequence of the restriction of supply due to the economic shutdown and the increase in demand for “stimulus” checks. The massive M2 money supply surge has reversed and is about 9 months ahead of inflation.

Economic downturn, current economic downturn, coming recession in 2023

While the Fed is raising rates to curb inflation, shrinking money supply is doing the work for it.

Economic downturn, current economic downturn, coming recession in 2023

Driving with the mirror

There is no doubt that we are in the midst of an economic downturn. As the Federal Reserve focuses on fighting inflation by tightening monetary policy, thereby slowing economic demand, logic suggests that economic data trends will continue to decline.

As the Fed continues to hike rates, each hike takes about 9 months to work its way through the economic system. Therefore, rate hikes from March 2020 will not appear in economic data until December. Similarly, subsequent and more aggressive Fed rate hikes will not be fully reflected in economic data until early to mid-2023. As the Fed raises in subsequent meetings, these hikes will continue to compound their effect on a heavily indebted consumer with little savings thanks to higher living costs. We have shown previously that the consumer is exceptionally ill-prepared for such a result.

Economic downturn, current economic downturn, coming recession in 2023

Since the Fed manages monetary policy in the “back view” mirror, more real-time economic data suggests the economy is rapidly moving from an economic slowdown to a recession. The signals become clearer from the inverted yield curves at the 6-month rate of change of the leading economic index.

Economic downturn, current economic downturn, coming recession in 2023

The media and the White House will likely claim victory by declaring that the first two quarters of 2022 were not a recession but only an economic downturn. However, given the lag effect of changes in the money supply and rising interest rates, the indicators are quite clear, the risk of recession is very likely in 2023.

For investors, this suggests that the current market rally is not the start of a new bull market. Instead, investors will likely be drawn to a bear market rally with disappointing results.

Currently, investors are hoping to catch “Fed Pivot Market Bottom”, however, in a bear market, it is often better to be late than ahead.

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