Over the past year or so, there has been considerable talk about a recession. In early 2023, many economists believed there was a slightly better than 50% chance our economy would experience a mild recession with high inflation and rising interest rates. However, with inflation issues appearing to wane and interest rates holding steady, the impending recession has yet to come to fruition. In fact, the economy accelerated at the end of 2023 and is expected to continue that trend into early 2024.
We have had an inverted yield curve since October 2022. An inverted yield curve occurs when short-term interest rates exceed long-term rates, and it is widely considered a harbinger of a recession. Under normal circumstances, bonds with longer maturities typically carry higher interest rates than short-term bonds. Currently, the three-month Treasury bond yields around 5.35%, while the 10-year Treasury yields around 4.3%.
The Federal Reserve, which essentially controls short-term interest rates that affect growth, looks to the Leading Economic Indicators (LEI), a series of 10 interrelated data points that measure different areas of economic activity, to provide insight into where our economy is headed. Federal Reserve Chairman Jerome Powell has said that monetary policy is data-dependent, with future policy decisions depending on how the economy fares in the coming months. The LEI, which includes the interest rate yield curve, has been negative for 23 consecutive months. While each component of the LEI can affect another, the LEI is not a perfect system. Indicators can dip for several months and then accelerate without a recession. Furthermore, the time between a turning point in one metric and the change in another can be 12 to 24 months.
The likely cause for such mixed signals is that the recession of 2020 was so atypical that it threw many data series out of balance. It is common for the economy to give mixed signals, for example, our inverted yield curve and still expanding economy. Having the components of the LEI half up and half down is consistent with an economy in flux. The business cycle doesn’t dictate that the economy must experience a recession.
Bright spots in our economy have been strong consumer spending and the tight labor market. When the Fed began raising interest rates, they expected unemployment to reach between 6% and 8%. Yet, here we are with the Fed Funds target rate set at 5.25% to 5.50% and unemployment for January 2024 at 3.7%. Part of the reason is that the labor market became so far out of balance during the pandemic. We lost nearly 14.4% of headcount employment during the pandemic, with people unable to work. About a year and a half ago, we had 12 million unfilled jobs. However, with interest rates rising, we have seen hiring slow, and we now stand at 9 million job openings, indicating the labor market is softening.
Likewise, consumers had increased savings from the pandemic when spending was shut down, in addition to the stimulus checks. Despite consumer sentiment reaching its lowest point ever on record in June 2022, retail sales never imploded as consumers drew down their savings. Additionally, consumers will continue to spend if they’re employed, which has raised expectations going forward. With low unemployment and cooling inflation, we may be in for the economic “soft landing” the Fed aimed for. Time will tell!
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