The economy may not be stalling after all

My son is an early riser. I am not. 

This morning the little gentleman got me up at 5:45, announcing that this was a father-and-son morning and he intended to get the most out of it — unless of course I wanted to resist, in which case it would be a father-and-son-and-cranky-little-sister morning. At 6 years old he already knows how to use his leverage.

And so there I was in the pre-dawn hours listening to the radio, large high-octane coffee in hand, when I heard a piece about how fears of a recession in 2023 seem to be fading, at least according to Moody's Chief Economist Mark Zandi. The argument he laid out was that interest rates appear to have crested and the Federal Reserve is likely to hit the brakes later this year when it reaches around 5%; supply chains, the original cause of the inflation spike, have largely rebounded, with energy and commodity prices leveling off; high-profile layoffs in tech and other sectors are not indicative of the broader economy, where hiring remains strong; and economic growth seems strong enough to weather its challenges.

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Contrast this to what banks have been saying for the last several months. Citigroup CEO Jane Fraser said in December that she expects a recession to take hold in the second half of this year, and JPMorgan Chase Chairman and CEO Jamie Dimon similarly said last October that a recession was "likely" in 2023. In earnings calls this month, banking executives have variously characterized the coming recession as "mild," "shallow" and "slow-grind" — attenuating adjectives for a recession, but a recession nonetheless.

So if banks are bracing for a recession that may never come, does it matter? It might. One of the reasons is largely semantic. A recession is conventionally understood to be two consecutive quarters of falling growth, but is sometimes misconstrued as two consecutive quarters of negative GDP growth. But that hard-and-fast rule doesn't always apply in all cases — indeed, by that definition the U.S. was already in and out of a recession last year. As a result, economists tend to lean on more holistic and fuzzier rules for what constitutes a recession — the National Bureau of Economic Research, for one, defines a recession as "a significant decline in economic activity that is spread across the economy and lasts more than a few months."

What that means is that economists know a recession when they see one, but what they are looking at right now is something of a head-scratcher. Interest rates did precisely what Fed officials have always said they never want interest rates to do — rise suddenly and precipitously to combat inflation. That led to a sell-off in the most vulnerable markets — namely cryptocurrencies — and corresponding slowdowns in interest-sensitive markets like housing. 

But on the other hand, that broader-recession vibe doesn't seem to have kicked in. The U.S. Bureau of Economic Analysis estimates that the United States' gross domestic product grew by 3.2% in the fourth quarter, and the Federal Reserve Bank of Atlanta's GDPNow real-time tracker puts it at 3.5% as of a few days ago, though that data point is produced by a model rather than by economists who can file down the rough edges of outliers. Even so, that seems like a robust starting point for an economy that is apparently about to stall.

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Unemployment also doesn't seem to be following the recessionary script. Unemployment right now is roughly the same as it was in February 2020 — that is to say as low as it was when the economy was at its pre-pandemic peak. And yes, there have been a lot of layoffs at Twitter, Google, Meta, Microsoft and other tech firms, but those dips may or may not be a harbinger of things to come: Automakers are apparently scrambling to pick up those very engineers that just got let go. 

And more to the point — and to borrow an observation from Chris Thornberg of Beacon Economics — a recession is fundamentally about a secular decrease in demand, typically brought on by some kind of sea change in what people are demanding. Tulips in Amsterdam, beanie babies, dot-com stocks and mortgage-backed securities have all lived through the experience of being in high demand one day and languishing in a landfill the next. NFTs are a possible exception — I can't quite put my finger on another fashionable curio whose star has fallen, yet NFTs are nowhere close to bringing down the economy.

The reason this observation is cautionary is that business economics can be as much about perception of reality as it is about reality itself. If enough financial intermediaries decide that we're in a recession and stop making loans, pretty soon that prophecy becomes self-fulfilling. If a recession is in the eye of the beholder, banks would be well advised to wait and see.