Recent data suggest the risk of recession is lower than previously thought, but it remains our central case for the UK and the EU. The UK posted zero growth in Q4, avoiding two consecutive quarters of negative growth, which is one way of defining a recession. However, this may be revised down, which would imply two consecutive quarters of negative growth in the UK in Q3 and Q4, thus a “technical recession”. The US hangs in the balance still, with equity markets and sentiment sending negative signals, but payrolls and activity data pointing the other way. Can the US avoid recession?
Answering that question is complicated somewhat by the fact there is not one single definition of recession. Although the US Bureau of Economic Analysis has estimated that the US had two consecutive quarters of negative growth in Q1 and Q2 of 2022, other indicators, such as unemployment levels, are also important in concluding whether a country has entered recession. Data from the US labour market suggest that the US has not entered recession – US payrolls (although a lagging indicator of recession) are strong.
On the other hand, equity market signals and Fathom’s Economic Sentiment Indicator (ESI), a composite of measures of consumer and business confidence, are both negative in the US, implying a higher risk of recession. However, the US avoided recession in 2012 with a stronger negative ESI than the current level. While these negative signals are important to take into account when analysing whether the US will enter recession, one also needs to consider other data.
One of the big questions for economists is: what happens when first-round effects of inflation, such as higher energy, food and goods prices, are in the past? How sticky will inflation be? The answer, in the US, appears to be a reasonably benign one. All measures of inflation are now falling, and a gradual drift back towards the target looks the most likely outcome from here.
Additionally, medium-term inflation expectations are back to pre-pandemic levels.
It is worth mentioning that an appreciation of the dollar, caused by FX investors moving to the ‘safe haven’ of the dollar as the risk of a global recession increased, has reduced the inflationary pressures of import prices in the US compared to other countries.
Furthermore, the Fed increased the policy rate quicker than the EU and the UK, which helped to anchor medium-term inflation expectations. The Federal Funds Rate remains a long way below the Taylor rule-implied rate, but the gap is narrowing and is now close to a ‘“normal” range, as illustrated by the chart below.
In terms of the labour market, payrolls are close to their pre-pandemic trends, both in the private and the public sectors, providing no evidence of US recession as yet. However, payrolls is a lagging rather than leading indicator of recession, mainly useful as a confirmation after a recession has occurred but not usually used as an indicator to foresee a recession coming.
So has the US avoided recession? If we combine the data on payrolls, equity markets, economic sentiment and GDP growth in a simple Vector Auto-Regression (VAR), which is usually a good way of producing a short-term forecast, we find that the US is likely to experience a couple of quarters of contraction during the course of 2023, and the annual growth rate will drop to zero before recovering. On balance, Fathom believes that the US will just about avoid recession.
The views expressed in this article are the views of the author, not necessarily those of Refinitiv Lipper or LSEG.
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