Despite what some say, the US economy is not in recession. To be clear, a recession is not defined as two-quarters of negative GDP growth. The National Bureau of Economic Research (NBER) has a Business Cycle Dating Committee that determines official US recessions. They define a recession as “a significant decline in economic activity that is spread across the economy and that lasts more than a few months.” That’s deliberately vague, with room for discretionary judgment, but they specifically look at industrial production, total employment, personal income and expenditures, and retail sales, among other indicators of aggregate economic activity. Currently, five out of the six known indicators that the committee watches are moving higher.

Also, The Conference Board (a non-profit research group) compiles a Coincident Economic Indicators Index that does a good job tracking official expansions and recessions. That index has moved higher each month this year. It was up in January, February, March, and April (the May data comes out on June 17th). So, it’s unlikely the US economy is currently in a recession.

A review of the data suggests that recession risk over the next six months remains relatively low (under 35% if I had to estimate). But recession risk over the 6-24 month window is elevated. In large part that elevated risk is due to the rapid pace of fiscal tightening (having overdone it on stimulus the last two years). Government receipts (dollars taxed out of the economy) are rising rapidly, and outlays (new dollars spent into the economy) are falling rapidly. Some of that is due to normal automatic stabilizers (e.g., fewer unemployment benefits paid out as unemployment declines) and some of it is due to roll-off of pandemic-specific relief programs. With gridlock likely coming after the mid-terms, fiscal policy could become outright contractionary next year. Even given the slight drop around the leaked Roe v Wade decision, the Republicans are expected to easily gain control of both the House and Senate in the fall mid-term elections—87% probability of taking the House and 77% probability of taking the Senate according to betting markets. However, one area of deficit spending that could receive bipartisan support is defense (due to the ongoing war in Ukraine and concerns about Taiwan).

Direct fiscal support to households created about $2.6 trillion in excess savings in 2020 and 2021 combined. Those excess savings are now being drawn down. In other words, the monthly savings pace is now below pre-Covid levels. Nevertheless, there is still a buffer of accumulated excess savings that will last for a while. On a positive note, the reduced fiscal support should help incentivize a return of the supply-side (e.g., a quicker recovery in the labor force participation rate) and should help bring down inflation. In my view, tightening fiscal policy will do more to bring down inflation than tightening monetary policy. But both are working in the same direction.

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Indeed, there is a risk that both fiscal and monetary policy will over-tighten and drive the US economy into recession in 2023 or early 2024. As one commentator quipped: the Fed is so far behind the curve they’re actually ahead of the curve. The way I conceptualize that, the Taylor Rule (a guideline of where the Fed funds rate “should” be) peaked before the Fed even started raising rates. The Taylor rule comes in various forms and, in my view, needs adjustment for the chronic decline in the neutral real rate (r*), but it is directionally accurate for the most part. The Taylor Rule currently suggests that the Fed should be cutting rates, albeit from a higher level. A relevant question is: at what point will the Fed be behind the curve on easing? Monetary policy acts with long and variable lags as Fed officials used to constantly reiterate.

Even though the Fed has only hiked 75bps so far, financial conditions have tightened materially through so-called forward guidance. The tightening is perhaps most noticeable (and impactful) in the mortgage market. Mortgage rates have risen from about 3.3% at the beginning of the year to about 5.5% currently. A household with a mortgage payment budget of $3,000/month could afford an $850k house at the beginning of the year and can now only afford a $650k house (assuming 20% down and a 30-year fixed-rate mortgage). That is roughly a 25% decline in home price purchasing power. Tighter financial conditions should dampen aggregate demand in the economy.

Turning to last week’s jobs report, the data provided a happy medium of strong employment gains and a stable unemployment rate. A stable or even slightly rising unemployment rate with ongoing solid job gains (roughly 150k-400k per month) would increase the chances of a soft landing. In order to get a soft landing, we would need to see job growth in-line with, or a little bit slower than, total labor force growth. Importantly, the unemployment rate is not something that the NBER considers in determining economic recessions, total employment is. It is possible to have a rising unemployment rate and rising total employment, the latter is far more important.

Looking at the JOLTS report, ongoing increases in hires with a declining number of job openings would be the soft-landing scenario. While some might be skeptical of those changes, such a benign convergence did happen from late 2018 to early 2020 (when the would-be-soft-landing was hit by the exogenous shock of Covid). Anecdotally, we continue to hear of companies implementing hiring freezes. Fed Chair Powell has said he would like to see job openings (currently about 11.5 million) come down to more closely match the number of unemployed (currently about 6 million). The current ratio of job opening to job seekers, nearly 2-to-1, is indicative of excessive demand.

Looking at the global growth cycle picture, global manufacturing PMIs are converging together in the low 50s. The lowest readings are moving higher and the highest readings are moving lower. The world economy is approaching an important crossroads. Is the deceleration in global growth seen over the past year going to continue into an outright contraction or stabilize and reaccelerate? I’d guess the latter. China is reopening from its recent Covid-lockdowns and a close study of the latest data shows some improvement in breadth and direction.