We’re Nearing a Recession, and Why That’s a Good Thing

People are tired of hearing about a recession and to be or not to be.  Like any headline the media grabs hold of, and then beats into submission, it loses its excitement and numbs the audience.  Inflation.  Debt ceilings.  Interest rates.  Bank turmoil.  Recession.   Recession.  Recession.  So, as I write this op-ed in May of 2023, what’s different now versus this exact debate from 20 months ago?  Is it fair for the public to say, “Let’s just get this over with already.”?  Read on and then you can smile and tune out, at least for a little while.

The U.S. economy is at greater risk of slipping into a recession.  I know, you haven’t heard that one before.  But here’s why:

Reason #1:  Financial distress from regional bank failures has created new headwinds.  What has been the marquee symptom of inflation and the Fed’s interest rate hikes, may be the marquee cause of a recession, if there is one.  Businesses may slow their hiring and capital expenditures in preparation of a recession.  At the same time banks are tightening their lending standards to improve their balance sheets amid public outcries of improper management, and brace for similar adverse consequences of markdowns on their commercial real estate loans as was felt by fixed income assets devalued by rate hikes.  Banks have often tightened their lending standards leading up to a recession, and then dramatically eased them, often prompted by regulators and the Fed, to climb out of the recession. 

Reason #2:  The seemingly invincible labor market is finally starting to cool.  The unemployment rate has likely appeared stronger due to a structurally smaller labor force than prior decades as baby-boomers retire.  As of April 2023, the unemployment rate sits at 3.4%, still historically low, but there may be a more meaningful metric.  The “cooling” effect may come by way of wage growth that has continued to lag inflation for nearly two years, or better said as inflation has outpaced wage growth over this timeframe.

Reason #3:  The US Personal Savings Rate is 5.10%, versus the 8.9% long-run average.  Meanwhile, credit card debt is expected to eclipse a record $1 trillion with average interest rates exceeding 20%.

Reason #4:  The US government is dangerously close to eclipsing its debt ceiling.  Treasury Secretary Janet Yellen warned that the government could default as early as June 1, which could cause, in her words, widespread “economic chaos”.

Each of these reasons fits the narrative of an economic recession.  So, why is this a good thing?

While financial pundits were debating the possibility of a recession in 2022 and what the fallout might look like, the stock market crashed.  There may not have been massive bank failures or near government defaults, but the S&P500 dropped nearly 20% and the Nasdaq Composite fell 33%.  

The obvious cause for 2022 and 2023’s recession fear was the Fed’s rapid rate hikes, of which the obvious cause was inflation.  The CPI (Consumer Price Index) rose 4.9% year-over-year in April.  This is still above the Fed’s 2% target rate, but after having delivered 5.00% in rate hikes over the past year, inflation is almost half where it was at 9% in June of 2022.  The global supply chain has improved since the pandemic and the price of energy has retreated since Russia’s invasion of Ukraine, suggesting brighter days to come.

As for the bank scares, it is likely that the turmoil felt this far will be limited to a select few regional banks.  While economic conditions and poor management were true, the big 3 failures thus far in 2023, were victims of a very concentrated depositor base that panicked.  Banks are far better capitalized than they were in 2008.

Regarding the potential US federal default and Great Depression-like scenarios painted by bickering politicians, Congress has enacted 78 times to raise the debt limit since 1960, and has already voted to do so this time around.

The 4 reasons outlined above present a paradox in that we may be near a recession, but also that the Fed is nearing the end of its rate hiking cycle.  The Fed may have completed its job of scaring/slowing and economy that grew too inflated with hubris.  If the American economy now appears scared, recall that investing amid periods of low consumer confidence has historically yielded better subsequent 12-month returns than investing during periods of high consumer sentiment.  While 2023 has displayed some of the further reaching effects of rapid rate hikes, the S&P500 is positive roughly 10% year-to-date and the Nasdaq up 21%, as most blue-chip companies’ earning reports beat estimates thus far.

So, America, get near the recession, preferably not in it, and then please move on quickly.  Lastly, do not forget that the formal economic term of recession is just that, a term, one likely not to be breached because of the unemployment requirement, but even if so, it is a term, not a button that once pressed unleashes mayhem.

Written by Bryan M. Kuderna.

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