The probability of the US economy again falling into recession at some point
is nearly certain if not completely certain. Perhaps the better
question is 'When will the next US recession start?" Policies perhaps
pulling the economy in opposite directions could make the analysis more
complicated.
People
frequently look to the yield curve to get a sense of when a recession
may hit. For a while, the United States Treasury yield cure, showing
the interest rates on US federal government debt over different terms to
maturity (for example two years versus ten years), has been largely
inverted over many if not most time horizons. An inverted yield curve
has interest rates on shorter term debt exceeding interest rates on
longer term debt. Normally, the US Treasury yield curve is upward
sloping where interest rates on shorter term debt are below interest
rates on longer term debt. The thinking here is that savers must be
compensated for either (a) doing without their funds for a longer time
period by tying up the funds in the debt or perhaps (b) having to sell
the debt before maturity and potentially subjecting the savers to
transaction costs and possibly capital losses if interest rates in the
market have risen after the issuance of the debt previously purchased by
savers. Regarding the latter, readers should realize that interest rates and the resale prices of previously issued debt move in opposite directions.
According to
expectations theory, an inverted yield curve, where shorter term
interest rates are higher than longer term interest rates, could suggest
that financial market participants expect that the future will bring
lower inflation, higher money supply growth, and/or lower real GDP
growth. Perhaps from a different perspective called preferred habitats,
a yield curve inversion could indicate a relative increase in the
demand for longer term debt (helping to drive longer term rates down as
the resale prices of such debt instruments rise) or a decrease in the
demand for shorter term debt (helping to push up longer term rates as
resale prices fall). Readers can refer to sources such as Chapter Seven
of Burton and Lombra (2006) for more about the yield curve.
Bauer
and Mertens (2018) and others have noted that an inverted yield curve
has predicted future US recessions with high accuracy. In fact, Bauer
and Mertens (2018) note that at the time of their study, an inversion of
the one-to-ten-year US Treasury yield curve (perhaps using monthly data) in recent decades preceded
all US recessions within about two years of the recession up to the time
of their study and had only one 'false positive' result in the time
period of their study. Readers may want to know that the US Treasury
yield curve inverted in 2019 after the Bauer and Mertens (2018) study,
and the US entered a recession about one year later, in early 2020.
According to data from www.worldgovernmentbonds.com (full web address
below), the most recent inversion of the 1-to-10-year US Treasury yield
curve occurred in July of 2022 and as of this writing has remained below
since then.
Based on
less than two years since the most recent inversion of the US Treasury
yield curve, will another recession in the US begin soon? Access to
credit can be extremely important for keeping the economy growing.
Relatively recently, billionaire Marc Lasry appeared on CNBC with Scott
Wapner and stated that he believed that a US recession was coming soon.
Lasry explained that business borrowers were approaching Avenue Capital
Group, a company that Lasry co-founded and where he is CEO, to ask for
loans at interest rates between 10 % and 15 % because these business
borrowers could not get loans elsewhere. While the Federal
Reserve Bank a while ago ended quantitative easing or buying assets with
longer terms to maturity to add liquidity to the economy, my
understanding is that the Fed now is continuing quantitative tightening
or selling assets with longer terms to maturity, taking billions of reserves out of the financial system and making it harder to get loans.
The drying up of access to credit could cause a recession.
Additionally,
consumers may have to pull back on spending. Millions of people have
been having difficulty keeping up with inflation. Data from the Board
of Governors of the Federal Reserve System (2023) show that
delinquencies on credit card payments have been rising again.
Unfortunately, that could imply a decrease in consumption and a
recession on the horizon. Tighter monetary policy in the form of higher
interest rates and lower money supply levels from the Federal Open
Market Committee (FOMC) of the the Federal Reserve Bank, implemented to
reduce inflation pressure, could be playing a major role in terms of
reduced access to credit and the financial burden of credit card
payments.
US federal
deficits had been falling for at least a bit after ballooning during the
COVID-19 pandemic. Recent increases in federal deficit spending could
have helped to keep the US economy out of another recession to this
point. However, some may be concerned about the sustainability of
continued deficit spending. Among their concerns, they may worry that
increasing deficits could reduce investment in physical capital such as
construction and new machinery. Others may question how the deficit
spending is being used. For example, is the deficit spending being used
in the most effective way to stimulate economic growth? Regardless, by
giving households and businesses in the aggregate greater spending power
by increasing after-tax income, the deficit growth all other things
equal increased aggregate demand (AD) and real GDP in the US.
Have
recent fiscal policy and monetary policy in the United States been
pulling the US economy in opposite directions? More specifically, have
increases in the deficit all other things the same increased AD and real
GDP but the FOMC raising interest rates and reducing the money supply
all other things equal reduced AD and real GDP? Can the US economy
experience a soft landing, with slower economic growth (and lower
inflation rates) but without a recession? Or, will the yield
curve again correctly predict another recession within two years of
its inversion?
Alternatively,
did the unusual circumstances behind the COVID-19 shutdown and
recession and the very expansionary policy response lead to a situation
where a hidden recession occurred before the yield curve inverted
rather than after? In other words, did the unprecedented events of the
recent pandemic change the timing of events related to the inversion of
the yield curve and a recession? Note that seasonally adjusted US real
GDP growth was negative in the first and second quarters of
2022. Further, note that according to Horpedahl (2023), private sector
employment from the Business Employment Dynamics survey (not the nonfarm payroll employment series) was reported as a loss
of more than 285,000 jobs in the second quarter of 2022. This sounds
like the US economy was approaching an 'official ' National Bureau of
Economic Research-declared recession if it did not reach a recession in
2022. Further, using a textbook-style definition of a recession of
consecutive (or perhaps nearly consecutive) quarters of contraction in
real GDP, the US economy did have a recession based on that definition. Again, did the unusual circumstances lead to a recession coming before the yield curve inversion rather than after
Or,
was this possibly hidden recession of 2022 delayed and perhaps hidden
due to very expansionary policy in response to COVID-19, and this was
the recession forecasted by the yield curve inversion of 2019? As yet
another possibility, did the yield curve in 2019 forecast a US recession
either in 2020 or 2021 due to problems developing in corporate debt
markets, and COVID-19 'masked' the recession that unfolded in 2020,
making it appear to be due solely to the pandemic but perhaps it was
partly due to corporate debt problems?
At
any rate, it remains unclear whether the US will have a recession
starting in 2024. To the extent that tighter monetary policy could
cause a recession, a reversal could perhaps prevent a recession.
However, to the extent that expansionary fiscal policy helped the
economy to avoid a recession, tighter fiscal policy to reduce the
federal deficit could help to tip the economy into a recession.
Expansionary
policies implemented to reduce the harmful effects of the
COVID-19-associated-recession have almost certainly had the unfortunate
consequence of creating inflation pressure. Is there a practical,
feasible way to reduce the costs imposed on people when inflation is
greater than or less than its forecasted value? Somewhat similarly,
will policymakers take steps to increase incomes for hard working
families soon? Could such policies help to achieve a soft landing?
REFERENCES
Bauer, Michael D. and Mertens, Thomas M. (2018) “Economic Forecasts with the Yield Curve.” March 5, 2018. FRBSF Economic Letter. 2018-07
Burton, Maureen and Lombra, Raymond (2006) The Financial System and the Economy: Principles of Money and Banking, fourth edition. Thomson South-Western, Mason, Ohio.
Board of Governors of the Federal Reserve System (US) (2023)
Delinquency Rate on Credit Card Loans, All Commercial Banks [DRCCLACBS],
retrieved from FRED,
Federal Reserve Bank of St. Louis;
https://fred.stlouisfed.org/series/DRCCLACBS,
December 11, 2023.
Horpedahl,
Jeremy. (2023) "Counting Jobs." Economist Writing Every Day, January
25, 2023. Retrieved online December 11, 2023 from https://economistwritingeveryday.com/2023/01/25/counting-jobs/
