It is striking how bad economists are at predicting a recession. They have shouted so many times now that a recession is coming, that they have just dug in and knowingly stuck to this tunnel vision.
At the end of last year, as many as 85 per cent of economists in the United States assumed a recession. Earlier this year, this percentage had fallen to 20 per cent, but the combination of disappointing inflation figures and a banking crisis is pushing the percentage up again. Given the poor track record of these economists, there is a natural tendency to think contrair.
Why there will be no recession
Interest rates may have risen sharply, but in historical perspective, the interest rate level is not that high yet. Policy interest rates are now equal to inflation and the inverse yield curve means that there are still real negative interest rates in capital markets. Due to the inverse curve, monetary policy is still stimulative. There has never been a recession when real interest rates are negative. Even if real interest rates do turn positive later this year, it will take six to 12 months before their effects are felt. Also, the inverse yield curve is not a good indicator; it is often inverse without a recession following.
Furthermore, the labour market is still far too strong for a recession. Recall that much of economic growth is driven by consumers. The growth of new jobs has caused the total wage bill to rise more than inflation, not to mention all those Americans who fixed their 30-year mortgages below 3 per cent. Today’s mortgage rates are more or less equivalent to those before the Great Financial Crisis. Back then, those interest rates could not prevent a bubble in the housing market. Falling inflation will soon ensure real wage growth per individual too, so economic growth will get another boost. Consumers who have saved a lot in recent years and are now spending it in the hospitality industry.
The banking crisis will also ensure that a recession is unlikely this and possibly even next year. After all, the Fed has rapidly come up with additional money and reversed much of the quantitative tightening. In the end, financial stability always takes precedence over monetary stability.
Analogy with the late 1990s
The Federal Reserve’s response to the banking crisis is reminiscent of the central bank’s intervention in the second half of the 1990s. After a soft landing of the economy in 1995, stock prices began to rise. Back in December 1996, Alan Greenspan spoke of “irrational exuberance” in the financial markets. That remark triggered an unprecedented rally based on the narrative of Goldilocks. Everything was just right, neither too hot nor too cold.
In 1997, there was the Asia crisis, followed a year later by the LTCM crisis. Now there was the crisis in UK pensions, followed by the US banking crisis. The need for financial stability caused wider monetary policy then, this time is no different. That does mean that interest rates will remain low, probably even below inflation. Moreover, next November there are elections in the extremely polarised United States, not the time for the Fed to come up with a new controversial policy, but with the explicit objective of safeguarding financial stability. We also saw this polarisation in the 1990s, when speaker of the house Newt Gingrich visited Taiwan and stuck to the credit ceiling.
Now the last two speakers of the house have recently visited Taiwan and there will be another fight over the credit ceiling later this year. In the late 1990s, there was the lavish liquidity for the Y2K problem, now high sovereign debt has to be financed with central bank help.
Structurally higher inflation
Investors are more convinced than the Federal Reserve that inflation is temporary. Indeed, some interest rate cuts have already been priced in for the second half of this year. This is also the only explanation for the inverse yield curve. However, the central bank has to choose between structurally higher inflation or a much longer period of tight monetary policy. In either case, capital market interest rates rise. In the first case, priced-in inflation expectations are too low; in the second case, real interest rates go up further.
In addition, a recession is already partly priced into the stock market. That while unexpectedly strong economic growth, helped in part by China, combined with higher inflation rates will be beneficial for corporate earnings trends. The final outlet for all the monetary craziness is via the various currencies in countries where unconventional monetary policies have ruled the roost.
Han Dieperink is chief investment strategist at Auréus Asset Management. Earlier in his career, he was chief investment officer at Rabobank and Schretlen & Co. This contribution originally appeared in Dutch on InvestmentOfficer.nl.