Expect recession to be announced in US by next spring: Nick Parsons

“Although markets are already suggesting that the Fed is going to have to pivot next year, the market is saying that the Fed will actually be cutting interest rates three times in 2023,” says Nick Parsons, Head of Research & ESG, Thomas Lloyd.

US futures have slipped. Bond yields are rising higher. Oil is now hovering below $100 a barrel which suggests that demand is falling. The economy of the world is slowing down. In the last 100 years, whenever the bond yields curve has inverted, recession has hit the US economy within the next 9 to 22 months. How close are we to hitting recession and if so, how is it likely to play out in the markets?
We will find that in spring of next year the NBER (National Bureau of Economic Research) will move to declare that the US is in recession and the reason I say that is by then we will have seen increased job losses, a falling housing market. We would like to see the year-over-year rates of retail sales and industrial production moving into negative territory.
All those things together will be enough to prompt the NBER to declare recession in the first quarter of next year.

What are your concerns right now when you look at the employment figures in the US and consider the prospect of recession there? How do those two correlate in your head?
Well let us try and square the colour of the US labour market and recessions. Traditionally recessions are accompanied by rising joblessness. The reason we look at employment levels is because that tells us something about the money that is in the consumers’ pocket. It tells us about the money which is available to be spent. And, of course, if fewer consumers are at work, then there is less money to be spent.

But actually inflation has a very similar impact on the labour market because even though the number of people in work are not declining and we have not yet got rising unemployment. What we have got is falling real incomes. So those people who are at work, are finding that their purchasing power is falling, their real incomes are declining and GDP numbers are measured in real terms not in nominal terms.

So, inflation through its impact on the real disposable income is having just the same pernicious negative effect that a rising unemployment would. I think it is possible to have a recession this time around alongside low unemployment rates, simply because the consumer spending is hit just as hard as if there was a rise in unemployment.

There could be surprise elements within a recession. The biggest recession that we have seen after 1948, The Great Recession, ran for about 18 months from December 2007 to June 2009. But regardless of how long this recession may last after it sets in, this time around, have we factored in much of it? Do you think we have surprises in store for us in market action?
One of the things that is going to complicate the policy response this time around is the likelihood that the Democrats losing the mid-term elections in November. Currently, they have a wafer thin majority but even with that tiny majority, President Biden will still not be able to bring his Bill to fruition. He could not get it through Congress and his political position likely is going to be significantly worse after November.

It is going to be very difficult to have a fiscal policy response. I simply see no chance of that helicopter money because of the political situation. So if you are not going to get a fiscal response, cannot we get a monetary response. Although markets are already suggesting that the Fed is going to have to pivot next year, the market is saying that the Fed will actually be cutting interest rates three times in 2023.

That is a huge turnaround just within the last few weeks. So the market is saying the Fed is going to have to pivot and the Fed will be doing the lifting for the US economy and that is why we have seen bond yields falling and that is why we have seen some support coming through to equity markets even as we see deteriorating economic numbers.

The market is telling us that the Fed is going to cave and then when we look at what the timing of that may be, it would not be in the next FOMC meeting because we are going to have a 75 bps rise in rates but remember the Fed had its annual offsite meeting at the end of August.

The Fed goes to Jackson Hole, they have the offsite meeting there and it could well be the focus of market attention when we get the conformation that we are going to be seeing a Fed prepared to offer support to the US economy and that is how I see things playing out near term.