RECESSION WATCH

Savings only
temporary respite for US

From Fathom Consulting:

(…) As we show in the US GDP fan chart below, both our central path for US economic activity, and our mean path which takes all scenarios into account, lie substantially below the consensus among other economists, which is for stagnation rather than outright contraction. It is fair to say that US growth exceeded our expectations in Q3. While US consumer confidence has fallen dramatically, that fall has taken place over many months; and timely indicators of economic activity, such as non-farm payrolls, remained strong at least until November — when they rose by 263,000 on the month.

To a degree our views were guided by precedent. Levels of consumer confidence in the US, the euro area and the UK have fallen to levels from which recession has never been avoided since the data were first collected around 50 years ago. This relationship is understandable, with domestic households accounting for 68% of all expenditure in the US, 63% of all expenditure in the UK and 53% of all expenditure in the euro area. Moreover, while both the US and the UK have once managed to bring inflation down from today’s levels without triggering a recession, that was as long ago as 1952.

Fathom has other reasons for sticking to its gloomier-than-consensus view. Looking at the data on non-farm payrolls, we find these typically flip, after calibrating to the size of today’s workforce workforce, from an increase of around 240,000 in the month when activity peaks, to a decrease of around 200,000 in the month after activity peaks. The employment data, then, do not give us a lead on recession. They may at best tell us that a recession has not yet started, although like some other macroeconomic data they can be prone to pro-cyclical revisions, being revised down when growth is slowing and vice versa.

The chart below shows how US consumer confidence has typically behaved either side of a peak in economic activity. While each of the seven recessions in our chart is different, on average consumer confidence starts to fall nine to twelve months ahead of a peak in economic activity. Statistical tests confirm that levels of consumer confidence contain information that helps to predict future GDP growth, while the reverse is not true.

After staging a partial recovery from COVID-related lows, US consumer confidence peaked in April 2021, and has fallen significantly since then as inflation has continued to rise. Statistical tests suggest that respondents to consumer confidence surveys are affected to a degree by money illusion, with a percentage point increase in consumer price inflation lowering confidence by more than a percentage point increase in wage inflation raises it. Even if wage inflation had kept pace with consumer price inflation, which it has not, it is likely that confidence would nevertheless have fallen.

We might have expected that the fall in consumer confidence would feed through to a decline in consumer spending, and with that economic activity, within the first few months of 2022. But consumer spending has held up. The resolution to this puzzle almost certainly lies in the personal saving data. The chart below illustrates not just the scale of the savings that were built up during the pandemic — effectively the difference between the green line, representing the average saving ratio in the five years leading up to the pandemic, and the blue line — it also shows that recently a chunk of those savings has been unwound, as the blue line has fallen below the green line. It is perhaps significant that the saving ratio fell by 2.8 percentage points in January of this year, from 7.5% to 4.7%, one of the sharpest falls on record, and it has continued to decline. If US households had been either unwilling or unable to dip into their savings from the beginning of this year, that would have represented a significant decline in aggregate demand that would likely have pushed the US into recession within a few months.

That US households have had the resources to maintain their spending despite close to two years of falling real wages is undoubtedly a positive. But the question remains: for how long they will be willing to continue in this way in a period of rising interest rates, when broader measures of wealth, both financial and physical, have been falling? Predicting recessions is far from easy.

That is because they are often caused by a sudden switch in sentiment, which in turn can become self-fulfilling. If US households start to fear for their own job security, for example, they might all choose to save a little more, precipitating the economic downturn. My chart below shows the first-round impact on US GDP in a world where each US household chooses to save a little more each week. Starting from a position where the US economy was growing at trend, which we estimate to be a little over 1% per annum, it suggests a scenario where households choose to save an additional $50 per week could be enough to cause a period of stagnation, with larger increases threatening recession.

The idea that recessions can become self-fulfilling, when households (fearing difficult times ahead) choose to save more and spend less, is known as the paradox of thrift. Popularised by John Maynard Keynes, it is one argument that is often used in favour of increasing state spending during a recession. The difficulty just now is that government financing costs have risen sharply in many countries this year, in real terms and over long horizons. There is perhaps a perception that, with both the Federal Reserve and the Bank of England beginning outright sales of the assets they purchased during the GFC and the pandemic, and the ECB announcing its intention to implement a similar policy of Quantitative Tightening from next March, the one-way bet on yields has been removed as monetary policy concerns come to dominate, at least for now.

Housing Starts Decline Less Than Expected; Building Permits Decline More Than Expected

Housing starts decreased by 0.5% to 1,427k (saar) in November from an upwardly-revised October level, against consensus expectations for a larger decline. Single-family starts decreased (-4.1%), while the more volatile multi-family starts increased (+4.9%).

Building permits decreased by 11.2% to 1,342k (saar), a much larger decline than expected. Both single-family (-7.1%) and multi-family (-16.4%) permits decreased.

Housing units under construction have flatlined and must decline before permits and starts recover.

Business Leaders Survey (Covering service firms in New York, northern New Jersey, and southwestern Connecticut)

Activity in the region’s service sector declined for a third consecutive month, according to firms responding to the Federal Reserve Bank of New York’s December 2022 Business Leaders Survey. The survey’s headline business activity index fell six points to -17.6. (…) Employment growth slowed noticeably.

The wages index, while still elevated, continued to edge lower, a sign that wage growth moderated. After falling significantly last month, the wages index retreated a further 3 points to 44.1, signaling that wage growth continued to moderate.

The prices paid index remained elevated but fell seven points to 72.2, pointing to a deceleration in input price increases.

The prices received index moved down seven points to 26.8, its third consecutive monthly decline and its lowest level since mid-2021.

• At least two-thirds of CEOs of the biggest companies surveyed said they expected the next six months to bring worsening customer demand, industry conditions, access to capital, and domestic and global growth, the survey from CEO advisory firm Teneo Holdings LLC found. (…)

Overall, CEOs based in the U.S. are significantly more bullish, with about three-quarters expecting improvement over the next six months, fueled by the relative optimism among chief executives of midsize firms. Meanwhile majorities in Europe and Asia expect conditions to worsen, the survey found.

Industries with more optimistic CEOs globally include financial and professional services, technology and consumer goods, Teneo found. CEOs in manufacturing and energy were more likely to be pessimistic. (WSJ)

• Yesterday, Evercore analyst Mark Mahaney slashed his revenue and earnings estimates [for AMZN] by 4% and 9%, respectively, for 2023. Supporting that conclusion: A survey conducted by the brokerage identified broad-based “belt-tightening” among consumers during the vital holiday season, highlighted by a “deceleration” in discretionary sales since the end of November. (…) Evercore’s Mahaney also flagged “several proprietary datapoints that suggest ongoing softness in . . . cloud computing demand.” (Almost Daily Grant’s)

FYI (video): Former central bank insider William White & Danielle DiMartino Booth, Quill Intelligence

China To Correct Past ‘Mistaken’ Housing Policies: Top Economist Top officials including President Xi Jinping pledged at a policy meeting last week to support housing demand in 2023. “That is a codeword for promoting the housing sector again,” Yao said.

China’s Workers Are Calling In Sick With Covid After Beijing’s U-Turn An abrupt end to harsh pandemic rules has left factories and businesses with little insulation from fast-spreading infections.

• Chinese Cities, Factories Tell People With Covid to Go Back to Work 

(…) Allowing Covid-positive people to work, especially in factories, will no doubt fuel the spread. Yet, some companies are willing to run that gauntlet, especially if their younger workforces don’t get too sick. (…)

“If they self-report, we will recommend they stay at home and recover. But the real situation is that many workers are infected, they don’t have serious symptoms, they choose to continue to work and not report their cases.” (…)

Now, with the initial case explosion appearing to ease off, Beijing is telling workers they don’t need to prove they are negative to return to the workplace, as long as they’ve done a week of home isolation.

Other businesses in China are still trying to limit spread within their factories, with crucial year-end production targets in sight. German carmaking giant Volkswagen AG is asking Covid-free workers to work longer hours at one of its factories in southern China, with a raft of employees out sick with Covid. (…)

To keep the site running, SES is splitting workers’ shifts, with Covid-infected employees going to work on Mondays, Wednesdays and Fridays and non-infected staff working Tuesdays and Thursdays.

Companies such as Apple Inc supplier, Foxconn Technology Co., and carmaker Geely are keeping their workers in closed loops as the Covid wave spreads. The systems see employees confined to the factory campus and tested regularly to keep the virus out.

Reopening has been accompanied by staff shortages and reduced output for businesses in other parts of the world, and the expectation is that China will have a similar experience, at a much greater scale, as it scraps Covid Zero. Mass absenteeism and delays in the world’s second-largest economy could have significant implications for supply chains and global growth. (…)

Xi Tells Russia’s Medvedev That China Wants Talks on Ukraine

Postal Service Outlines Plans to Convert Fleet to Electric Vehicles The agency said that of 106,000 delivery vehicles it expects to acquire between now and 2028, at least 66,000 will be electric.

Taliban Ban Women From Universities A new decree has broadened a ban on female education that has drawn international condemnation and isolated Afghanistan’s hardline government.

Surprise Bank of Japan Move Sparks Global Bond Selloff Global stocks and U.S. futures wobbled after the BOJ surprised investors by raising the cap on benchmark 10-year government bond yields.

Even the Bank of Japan, the last proponent of ultraloose monetary policy, is becoming fractionally more hawkish.

The Japanese central bank surprised nearly everyone in the market on Tuesday by raising its effective cap on 10-year government bond yields to 0.5% from 0.25%. Under its yield curve control policy, the BOJ has long intervened to keep bond yields within a specified target range near zero. This latest tweak effectively raised the interest rate for this tenor: 10-year yields shot up to 0.41% from around 0.25%.

After the BOJ said it would now allow benchmark bond yields to trade as high as 0.5%, the yen and bank shares surged, while the local equity market sold off.

BOJ Gov. Haruhiko Kuroda said the move isn’t tightening per se—rather it is aimed at improving the functioning of the government bond market since yields on different maturities had gotten out of whack. A 10-year yield cap of 0.25% made sense when the rest of the yield curve was very near zero too, but less so when rates at both longer and shorter tenors had risen significantly in line with the global trend this year. Ten-year Japanese government bond yields were indeed looking artificially low. Japan’s 15-year bonds were yielding 0.84% before Tuesday’s move while the nine-year bond yield was at 0.31%—both significantly higher than the 10-year yield.

But the market will still question if this is just a one-off tweak or a taste of a much broader shift down the road. The change comes at an interesting time: Local media recently reported that the Japanese government intends to revise its accord with the BOJ to give the central bank more leeway to adjust its ultralow interest-rate policy. A top government official denied the report. (…)

ING:

At the press conference, Kuroda tried his best to minimise market expectations for further policy changes. He stressed repeatedly that today’s move is not the first step towards an exit and a further widening of the yield band is not needed. We think today’s decision has undermined the BoJ’s credibility on future policy guidance. From the remarks made today, we are unable to answer our question, why now?.

Economists Place 70% Chance for US Recession in 2023

The probability of a downturn in 2023 climbed from 65% odds in November and is more than double what it was six months ago, according to the latest Bloomberg monthly survey of economists. The poll was conducted Dec. 12-16, with 38 economists responding about the chance of a recession.

The median estimates see gross domestic product averaging a paltry 0.3% next year, including an annualized 0.7% decline in the second quarter and flat readings in the first and third quarters. Consumer spending, which accounts for about two-thirds of GDP, is projected to barely grow in the middle half of the year. (…)

Economists expect payrolls to decline in the second and third quarters, and by the first quarter of 2024 the jobless rate is expected to peak at an average 4.9%.

And after firmer growth in the first half of the year, average hourly earnings are forecast to cool.

Inflation as measured by the Fed’s preferred gauges is seen softening [to 3.0% in Q4] but still running well above the central bank’s 2% goal. (…)

David Rosenberg:

The Fed seems to be ignoring the news, or perhaps is not convinced it is going to last, but in both October and November, we saw declines in two critical segments of the CPI: core goods (ex-food and energy) and services ex-rent dipped back-to-back. This has happened twice in the past (data back to 1985) — and both in recessionary/deflationary episodes: April-May 2020 and October-November 2008. This is a 1-in-200 event and received scant attention.

The Fed seems consumed with an allegedly hot labor market, but the numbers it focuses on, like job openings and the unemployment rate, are classic lagging indicators. Concern over wages as price momentum recedes is nonsensical. Wages are set on inflation expectations, and they are coming down discernibly.

Indeed, as this NY Fed survey released yesterday shows. Inflation anchoring looks solid:

• Worker strikes surged in 2022

There were 374 worker strikes started in 2022 — a 39% increase over 2021, according to a database run by Cornell. (…)

According to Cornell, approximately 78,000 workers walked off the job in the first half of 2022, compared with 26,500 in the first half of 2021.

Strikes were on the rise, even before the pandemic — hitting a 17-year high in 2019, when 25 major work stoppages occurred, per BLS data, which only counts stoppages of 1,000 workers or more. (Cornell’s tracker, started in late 2020, covers all collective actions.) (…)

Sounds like a strong wave…until you link to the BLS data…

• Also from the NY Fed yesterday: rank and file workers’ expectations have peaked, even with rising inflation:

Data: SCE Labor Market Survey. Chart: Erin Davis/Axios Visuals

• BTW: Wage-Price Spirals: What is the Historical Evidence?

From the IMF:

How often have wage-price spirals occurred, and what has happened in their aftermath? We investigate this by creating a database of past wage-price spirals among a wide set of advanced economies going back to the 1960s. We define a wage-price spiral as an episode where at least three out of four consecutive quarters saw accelerating consumer prices and rising nominal wages.

Perhaps surprisingly, only a small minority of such episodes were followed by sustained acceleration in wages and prices.

Instead, inflation and nominal wage growth tended to stabilize, leaving real wage growth broadly unchanged.

When focusing on episodes that mimic the recent pattern of falling real wages and tightening labor markets, declining inflation and nominal wage growth increases tended to follow – thus allowing real wages to catch up.

We conclude that an acceleration of nominal wages should not necessarily be seen as a sign that a wage-price spiral is taking hold.

This Nordea chart merits attention, particularly the light blue bar. CPI-Services less rent of shelter (36% of core CPI and 50% of core services) was down 0.1% in October and zero in November. This is mainly fueled by wages and energy. It might also reflect lost pricing power for service providers.

Rosie adds:

(…) the Fed publishes its own uncertainty index for all the economic projections it makes in the SEP (excluding the funds rate). Participants are asked to assess how their uncertainty surrounding the outlook has changed since the last set of estimates, responding “higher,” “lower,” or “broadly similar.”

The aggregate amount of those responding “higher” uncertainty less those saying “lower,” divided by the total number of participants, results in the creation of a diffusion index over time. (…) doubt among the FOMC members’ outlook is at, or near, max levels — something not witnessed since the ’08-’09 Global Financial Crisis.

Maybe the BOJ is the first central bank to surprise markets…

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