According to the U.S. Federal Reserve, the odds of a recession in the next twelve months is 51.8178%, based on the Treasury yield curve.
This week in an economic discussion panel, I was asked about this data from the Fed and my view on the probability of a recession in the United States. In response, I repeated what I first inked here a year ago:
When it comes to calling this recession, we borrow advice from the Battle of Bunker Hill: “Don’t fire until you see the whites of their eyes.”
In other words — wait until we see it. There is risk in being late to the punch. But there is also risk in holding on to a stubborn outlook in the face of consistently contradictory data. So long as the economy continues to grow, the economy is growing.
This macroeconomic cycle has been remarkably hard to predict because of the highly unusual circumstances that created it. Rather than rowing in tandem, large sectors of the economy have been completely out of sync since 2020. There was the stay-at-home Amazon splurge while restaurants idled, followed by the service-revival and goods-cession. Manufacturing and freight — usually reliable macroeconomic indicators — languished for nearly two years, but other cyclical industries like construction picked up the slack. Tech boomed, bust, and boomed again, dragging the stock market along for the ride.
The impact of higher interest rates has varied widely, even within industries. Look no further than housing. Affordability has plummeted and yet prices are on the rise. Existing home sales have plunged while new home sales have held steady. Single-family and multifamily housing starts have moved in opposite directions for two years. If the adage “housing is the economy” contains a kernel of truth, what exactly can we glean from these contradictory dynamics? It’s certainly hard to tell.
The labor market — the bedrock of the economy — swung from a dramatic idiosyncratic disruption in the early days of COVID to extreme worker shortages in the aftermath. Employment data remains hard to parse today as the official unemployment rate rises despite payroll gains.
Even the inverted yield curve — a classic recession harbinger — has never flashed such a prolonged but ineffectual warning, as shown in the Fed’s model above. Perhaps the usefulness of this indicator has been tainted by the Fed’s forward guidance, first introduced in 2012, which suppresses long-term interest rates and distorts the yield curve.
Against this backdrop, traditional macroeconomic models calibrated on the “normal cycle” have failed to produce reliable signals. Instead, they have produced countless false positives that have steered many in the wrong direction.
I don’t pretend to have a better model, nor do I know when the next U.S. recession will occur.
In the face of uncertainty, I think the best approach has been to focus on the big picture. Payrolls have been expanding since April 2020. Real personal consumption expenditures (real PCE) has neatly tracked the pre-COVID trendline and shows few signs of wavering. Real wages have been growing since mid-2022. So long as the economy is growing, the economy grows.
Absent convincing data to the contrary, I maintain the view that the economy is on solid footing.
Untangling Employment
The latest data to reignite growth concerns was the Bureau of Labor Statistics’ May employment report which showed an uptick in the headline unemployment rate to 4.0%, the highest level since January 2022. Under normal circumstances, the creep higher in unemployment rate from a trough of 3.4% is a real cause for concern.
But the same jobs report showed an increase in nonfarm payrolls of 272,000 in the establishment survey, well higher than expected and indicative of solid economic growth. Likewise, ADP’s payroll report wavered slightly in May but continues to show consistent payroll growth. What gives?