Economists, experts, and the financial media have been warning for over a year that a U.S. recession is ‘just around the corner.’ The economy continues telling a different story.
Last month, the Bureau of Labor Statistics reported that payrolls grew by 339,000, with the previous month’s job growth being revised higher by 93,000. Workers are making more money, too – wages grew by 0.3% in May and 4% year-over-year, frustrating the Fed while showing little sign of deceleration. In all, real U.S. GDP grew by 1.1% in Q1 2023 (advance estimate) and 2.6% in Q4 2022, which all readers know isn’t the stuff of recessions.1
To be fair, recession forecasts have not been unfounded. In past columns, I’ve pointed to the inverted yield curve as a historical precursor to economic downturns, and the spread between the yield on the 3-month U.S. Treasury and the 10-year U.S. Treasury has been in firmly negative territory for months now (see chart below). I’ve also pointed out that the Conference Board Leading Economic Index (LEI) has decisively turned over—now down 4.4% over the six months from October 2022 to April 2023—which has preceded the last several recessions.
Yield Curve Inversions Tend to Precede Recessions
Source: Federal Reserve Bank of St. Louis2
Now there’s yet another signal flashing recession – the U.S. debt markets. Readers should broadly think about the debt market as one responsible for moving money from banks and lenders to businesses and households, which is of course paramount to driving economic activity and new spending and investment.
In the wake of the Fed’s interest rate hiking campaign and the regional bank stress this spring – the two of which are related – we’re starting to notice banks requiring more collateral from borrowers as well as charging higher interest rates on loans. Lending conditions for companies, households, and especially real estate developers are now nearly as tight as they were at the height of the pandemic.
In the corporate world, sales of new bonds have fallen fairly dramatically, and corporate bankruptcy filings are also starting to rise as cash dries up, with the highest number of filings since 2010.
For households, interest rates are on the rise for credit cards, auto loans, and of course mortgages. Higher rates have also taken a toll on loans with adjustable interest rates, which we think has factored into more households falling behind on payments. As seen in the chart below, delinquency rates on consumer loans are on the rise:
Delinquency Rates on Consumer Loans
Source: Federal Reserve Bank of St. Louis3
Nowhere has credit tightening been more apparent than in the commercial real estate market, however. In the realm of office space, landlords are not only collecting less revenue from tenants who are not returning to offices, but they are also facing higher interest expenses. Banks surveying the environment don’t like what they see – the ratio of money lent to property value has fallen to a 30-year low, and the debt markets are signaling the trouble. Commercial mortgage-backed bonds with AAA credit ratings currently pay ~2% higher yields than comparable U.S. Treasury bonds.
Bottom Line for Investors
The aforementioned tightness in debt markets is yet another signal that a recession appears likely for the U.S. sometime in 2023 or early 2024. Frustrating many forecasters, however, is the flip side of the argument which has been the same for the past year – a strong jobs market and higher wages may continue to be enough to stave off a downturn. The U.S. consumer is the most important component of the U.S. economy, and to date ‘full employment’ and higher wages have been enough to keep spending afloat.
Whether the consumer can continue to keep the U.S. economy growing in 2023 remains to be seen. For markets though, it may not matter. I would argue a recession has been priced into stocks for some time now, and only a worse-an-expected downturn would be enough to send stocks tumbling again. A recession that’s more ‘garden variety,’ which is what I’d expect, would probably not negatively impact stocks much at all, in my view. That type of recession is already too widely known and expected.
Disclosure
2 Fred Economic Data. June 2, 2023. https://fred.stlouisfed.org/series/T10Y3M#
3 Wall Street Journal. May 31, 2023. https://www.wsj.com/articles/where-is-the-u-s-economy-headed-follow-the-money-c79a6b1c
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