Is It Possible to Avoid a Recession?
The Challenge Ahead
The combination that we face of slowing economic growth and rising inflation requires walking a tightrope to face. Traditional economics tells us that as an economy enters into a slowdown, monetary policy should be easing restrictions to soften the blow of the downturn. Traditional economics also gives us the Philips Curve, which states that in the short term, unemployment rises as inflation falls. This is important because a consequence of bringing inflation down is unemployment. Hopefully by now you can see the issue the Federal Reserve faces.
The Federal Reserve faces a dual mandate: Maximum employment and price stability. Currently, maximum employment is no issue, as the unemployment rate is as low as it has ever been. Price stability is the issue, with inflation we have not seen in four decades. In Jerome Powell’s most recent press conference, he stated that the Federal Reserve believes they can continue to raise rates to bring down inflation without severely impacting unemployment.
Unemployment
This belief is already being tested. Tesla plans to cut staff by 10%. Coinbase is cutting 18% of their staff. Robinhood is cutting 9% of its staff, Microsoft, Google, and Apple are all slowing hiring. The list of companies laying off or slowing hiring, especially in tech, is expansive and seems to grow every single day. While these layoffs in tech are alarming, we are not seeing this in many other sectors, and it is important to note that tech saw massive growth over the past few years, and this can be seen as “returning to the mean”.
This chart above shows the Unemployment Rate (left y-axis) vs the Federal Funds Effective Rate (right y-axis). Looking at this chart, we see quite a few instances of the Federal Reserve stopping rate increases, beginning to lower rates, and then seeing unemployment spike. This is because unemployment is a lagging indicator, and in most cases the change in unemployment comes after the rate hike cycle.
This chart, for the exception of the Paul Volcker era, sees the consistent theme of a delay in unemployment reacting to the Federal Funds Rate. This is why the Federal Reserve believes we will not see unemployment increase significantly until 2024.
GDP Growth
In Q1 2022, GDP growth fell 1.5% compared to Q1 2021. Many economists do not believe we will see a recession in 2022, which on paper is 2 straight quarters of negative GDP growth. The Federal Reserve believes we will see GDP grow at 1.7% in 2022, much lower than previous growth projections. This would signal a significant slowdown in GDP growth, much lower than since the pandemic.
Currently, the Atlanta Federal Reserve projects GDP for Q2 2022 to come in at 0%. The slightest miss to the downside would put us into an official recession. While many economists do not believe this, it is a real possibility. It is important to keep in mind that if we went into a recession after the 2nd quarter of 2022, it does not need to continue on the rest of the year, but it would be a cause of concern for many individuals and investors, which could hurt the stock market in the short term.
Can We Avoid a Recession?
In the first section above, I discussed the wave of layoffs in the technology sector, and the lagging indicator of unemployment following the federal funds rate. In the second section on GDP Growth, I talked about what we saw in Q1 2022 and a projection for Q2 2022. But what does this have to do with the future, and is a recession inevitable?
Many economists are claiming we will not have a recession this year. Many companies tell a different story. Snapchat surprised the markets at the end of May when they lowered Q2 guidance due to the sudden change in macroeconomic conditions. Apple did not give guidance for Q2 2022, and warned that China lockdowns will have a significant impact on their profits. Although these tech companies tell one story, Kroger tells another: Kroger raises guidance for the rest of their fiscal 2022 as they see consumer spending shifting to Kroger’s own, more affordable brand. While this is good for company earnings, it paints a bleak picture in terms of consumer strength, showing that consumers are already starting to trade down in price levels.
As we watch consumer confidence levels hit new lows, companies lowering guidance for Q2 2022 and beyond, and layoffs begin in the tech sector, I do not see a possible way to avoid a recession. The question is not if we can avoid a recession, it is how long can we put it off for? Consumers are not getting a stimulus check any time soon, the Federal Reserve is tightening monetary conditions, credit card debt has hit an all time high, and with the stock market dropping with real estate soon to follow, the wealth effect will start to make people feel more poor.
I believe that we are currently in a recession, and once we get the official GDP numbers for Q2 we will know that. I could be wrong, matter of fact experts are screaming that we will not have a recession yet, but they have been wrong before. The consumer can only hold up so long against the wall of inflation, and once the consumer falls to the pressures of inflation, we will finally have a fighting chance to get inflation down, but this will take a painful recession to do so.