Calls for one of the most talked about recessions in history are starting to receive. Bank of America now sees that fed's interest rate hike ending in a soft landing out You might.
Have noticed that, after many months of bracing for a sharp downturn in the US economy, some prominent economists, CEOs and market watchers have begun to sound a bit more confident that the US will avoid a recession. But you might not want to count on it. Bloomberg's chief US economist Anna Wong, along with a team here at Bloomberg, crunched all the numbers, and she's here to explain why a recession is in fact still likely on the way and possibly soon.
There's always a chance this soft landing will be the reality. But I think that hinges on an assumption that this time is different.
I'm Weskasova today on the big take why the landing might not be soft and a you and Bloomberg's chief economist Tom Orlick right in this new analysis that when everyone expects a soft landing, brace for impact, Why do you say that, Why do you think that a recession is still the most likely outcome?
It's stumped from this observation where we look at the past recessions and found that indeed, media mentions of the word soft landing, and even corporate filings and corporate presentations research whenever the word soft lending is at a peak that actually precedes the two thousand and eight recession, that preceded the two thousand two, two thousand and one recession,
the nineteen ninety recession. There seems to be something there that made us to look deeper into why people tend to call on a soft lending right before recession, and overall, our takeaway from that exercise is that there's more reason to think that a recession is more likely than a soft lending.
So let's walk through the data that you compile for this article and all the things that went into this conclusion. You start the analysis with a quote from someone we're all very familiar with.
Yes Jennett Yellen. In October two thousand and seven, just two months before the Great Recession, she said that the most likely outcome is a soft landing. At that time, the economics data, very similar to today now points to things looking rosier than everybody expected. Economic data we're surprising on the upside. PMI was etching back up, which means Purchaser's Manager index. That index tends to be one of the earliest data that indicate whether the economy accelerating or decelerating.
So even that PMI survey shows an acceleration on the eve of the two thousand and then seven recessions. So I think that the confidence one could place on the PMI surveys is in terms of predicting the start of a recession, should be pretty low. We see a lot of similarities today. Our number one reason for why we still think of recession is most likely is because in the past recessions, the number one culprit for creating that recession is the FED, and the FED tends to murder expansions.
And if you look at the legs of monetary policy, what we learned is that even within a tightening cycle, there are various length to these lags. So I think one reason why the soft lending believers think that the tightening effects of monetary policy is over ready is because you see this reacceleration in manufacturing financial conditions earlier, when the stocks keep on rising, and we also see that
housing market is starting to turn up. Well, it turns out that those places are also where the legs of monetary policy are the shortest. The place where monetary policy takes the longest to work is the labor market and also in the credits market, And there are reasons to believe that these two places we have still yet to
see the majority of the rate hypes effects. And once these two places labor market and credit markets start seeing those effects, that is when you have this non linear downturn that will jump start a recession.
And another thing you write is that a lot of the assumptions underlying projections are that the trends we've been seeing are going to continue moving in the same way, and that that might not be the case.
When one think about soft lending, one is implicitly assuming that the unemployment rate will continue to stay low. But when you look at the lessons of recessions over the past fifty years, one thing that jump out at us is that usually when this recession begins, you see this non leniar jump in unemployment rate. It's very hard to forecast this non lenear jump and when this jump will happen.
I think the lesson is that when you look at all these mean forecasts showing a soft landing showing that unemployment rate would day between three point a to four point one percent next year. You are not taking into account the risks that skewed the distribution of forecasts on the upside. So once we put estimate on the risks based on historical episodes of recession, it just turns out that the upside risk of the unemployment forecast is way higher than low side risk to unemployment forecasts.
And one reason why these trends might not continue is that there are so many things that could sort of crash into those assumptions that are unpredictable.
So you're right. Recessions are usually happen not because the economy slowly drip drip dripped down to a low growth regime. It's due to a sudden confluence of shocks, and in fact, we are seeing at least five shocks in the immediate horizon. The first one is oil price shocks.
Oil has resumed a rally after an industry estimate pointed to a huge drawdown in US inventries, adding to signals that the market is tightening.
Aside from FED funds rate hikes, The second most popular culprit of recession is oil price increase. We have seen a twenty five dollars increase in oil price in just a matter of a couple months. That would shave off growth from consumption spending. Another second shock that we're seeing is that people are starting to repay their student loans again.
Now to federal student loan payments for turning after a three year pause, tens of millions of Americans. They are back on the hook this morning making those payments again amid stubborn inflation and rising interest rates.
We expect that that will pretty much take off about three hundred dollars per household in consumption and money that they could put toward consumption. Other than that, we still have a government shut down risk. The stop gap bill that was passed over the weekend only kicked the can down the world to about mid November where there would be another shut down negotiations again, So that will potentially
lead to seven hundred thousand federal workers being furloughed. On top of that, you also have the United Autos Workers strike.
In the United Autoworkers' Union, putting more pressure on the Big three US carmakers GM four than Silantis. It plans to expand its strikes if there is no progress in contract talks via Friday deadline.
Even though right now the strikes are pretty narrow that affecting only twenty five thousand auto workers, we looked into the supply chain relationships of the auto manufacturing sector and it turns out that the auto sector has one of
the longest supply chain in auto sectors. In other words, even though the strikes are concentrated in auto plants, because it sourced from so many other sectors such as steel, rubber, chemical, even service management consultant, when you have a paralysis of production in auto, you actually lead to layoff in all the other sectors. So we estimate that twenty five thousand autoworker strike could ultimately lead to one hundred and thirty
thousand layoffs across all the other industries. If the UAW strikes were too broaden too, the entire membership of the United Autos Worker Union, which is about one hundred and fifty thousand workers, that could ultimately lead to about seven hundred and sixty thousand layoffs across the entire economy. So it's actually a pretty substantial threat to economic growth.
There.
All these shocks could easily reduce about one percentage point off GDP growth in the fourth quarter and raise unemployment rate by enough to generate a recession.
And those are just the different shocks that could happen within the US. You also write that the rest of the world could wind up dragging the US economy down a bit.
Let's talk about China. China is the second largest economy in the world. Especially within China, the property market usually is a big factor in generating growth within China. Our team members from China are telling us that there is a structural weakness in the Chinese economy, some scarring effect within households after the pandemic that lead them to revise down China's growth through the medium horizon. If China does slow more visibly, that would affect commodity prices, that would
affect the motivation to invest in equipment spending. Usually when you see global growth slow down, the first place you see in the US economic data is in equipment's investment. So that could further drag down GDP growth.
When we come back, can consumer spending word offer recession and on one of the bright spots in the US economy even with the recession fears has been consumer spending has remained really strong, and now you're finding that maybe that might not last either.
One of the most popular cited reasons for the soft lend is the resiliency of consumption, right, and I would say that there are two reasons to doubt why consumption should not be a key predictor. Number One. In past recessions, services consumption remain resilient even in a recession. I think the median American household consumer is not a forelooking person. As long as you can borrow, you spend, So this
is why even in a downturm, people still spend in services. Second, if consumption does slow down, that as additional bad news on economic growth. And we do see some good reasons why it would slow down ultimately, and one of them is that I mentioned the resumption of student loan payments. We think that that would altogether add up to about seventy billion dollars per year spent on paying back student
loans instead of spending on things and services. Another reason is because all these pandemic savings that people had from either a paycheck from the government or from forced saving because they were not able to spend during the shutdown years, those savings are running down for about eighty percent of the American households. And finally, this summer, we actually saw a once in a blue moon kind of consumption spending splurreed.
That's due to three cultural phenomena in the US. Number one, you have the Barbenheimer movie release that led a lot of people to go back to movie theaters. And number two, you have Taylor Swift concert tours in the US. On top of that, you have Beyonces concert tour in the
US as well. Imagine this, Each person on average who go to a Taylor Swift concert pay fifteen hundred dollars for altogether at the concert tickets, hotel fans, memorabilia, airline tickets, and for Beyonce, the average concert goer spend even more because the typical fan of Beyonce is older than a typical person who goes to Taylor Swift concert. So what you see is then a Q three Barbenheimer Taylor Swift beyond explosion of things that cause people to spend irrationally
because they just want to go for it. And then in Q four you have this nuclear winter of entertainment because of Hollywood writer strikes no more Taylor Swift, no more Beyonce. So you have this cliff of services spending. So what we're expecting is this big drop off in consumption spending will start to become evident in consumption data in the coming months.
And Enna, you actually were able to put a figure on just how much all of these cultural events added to the US economy.
Yes, we estimate that those three things together added about eight point five billion to the third quarter growth in annualized growth domestic product growth terms, that is about zero point five percentage point. You added point five percentage point to Q three, then you must have point five percentage point subtracted off Q four if you'd no longer have those growth drivers.
That's an astonishing figure that those things could have such an effect on an economy as large as the US is.
It's like an Olympic event basically.
And you said that people will spend as long as they're able to borrow. And that's another thing that you found in your analysis that banks are starting to become a little stingier when it comes to lending out money.
We were searching for the one indicator which has a good track worker of predicting recession, and when I was reading the October two thousand and seven, FOMC transcript. I note that their staff was talking about all these positive economics surprises. Then the one indicator that showed that something bad is happening is the FED Senior Loan Officer's Survey or short for SLUS. That survey tells you what are
the plans of banks in lending. And typically when banks indicate that they're planning to reduce lending to consumers reduce lendings to firms, that has been a very good indicator of credit tightening. And when you don't have credit flowing freely in the economy, that's when you start to see more clearer signs of slow down in growth.
When we come back, what would it take to avoid a recession? This is all painting a pretty bracing picture of what may be ahead of us. And yet you also lay out what you call the arguments for the defense, the reason why maybe this won't come to pass and we will have a bit of a soft landing. Can you tell us what they are?
The best argument for a defense is if you believe that there's a productivity boom underway, possibly from AI. If you look at the past fifty years of history, of FED hiking cycles and soft landing. There had only been one successful case of soft landing, which happened in the mid nineteen nineties, and that was because Alan Greenspan decided not to further hike interest rates because he'd strongly believed that productivity growth is rising. Therefore wage growth could continue
to increase with that gen inflationary pressure. In this case, lately, we have been seeing a lot of labor strikes, right, and the settlement of these labor strikes shows that people are asking for four or five percent wage growth per year, and not only for this year but in the next
couple of years. In order for that to be consistent with the FEDS two percent inflation target, it means that productivity growth got to pick up to around two percent or even three percent from about one point five percent. I believe that the FED believes that trend productivity has been running at about one point five percent over the last couple of years. So if you do believe in that AI boom, the FED would allow this wage growth increase to happen and sit back and let productivity do
its work. But I would say that to have confidence about this judgment that productivity is rising is as hard as having confidence over what the neutral rate that our star is, and I think that Chair Powell will not have that kind of conviction, strong enough of a conviction of a productivity boom underway before he paused the rate hike.
And then some of the things that you're watching, which could spell bad news you say, could turn around and wind up actually being good for the economy.
Yeah. I mean, it could easily be that the UAW strike could end tomorrow and then government shut down could be completely averted if Republicans and Democrats decide to work together, and all that disruption would just be a rounding error
for Q four. It could also be that Bidenomics could be successful in reversing decades of economist's understanding of industrial policies, which is that while government subsidization actually helps spur private investment in these selected sectors and as a result, lead to an investment boom in the US, if that happens, we can totally avert a recession.
But I think we can all hear the skepticism in your voice. You don't really think that that's likely.
I think it really stems from our exercise in this piece of article, which is we go back to history and look at the probability of what is the most likely outcome, and yes, there's always a chance this soft landing will be the reality. But I think that hinges on an assumption that this time is different, and I just feel like it's such a hard argument to make that this time is different that I would still say our base case is a recession.
Enna if a recession does come to pass, is there any way of telling from all of these numbers that you're looking at how deep it will be and how long it might last.
Our base case is for a short and shallow recession. But it is a very low conviction call because you when a recession happens, it's because all shocks hit the economy at the same time and some kind of non linearity effect is happening. It's kind of like somebody in the movie theater is shouting fire and everybody rushes out of exit. It's usually a kind of like a freak out moment. It's hard to tell how severe it would be once those dynamics kick off.
Anna, thanks so much for giving us a look at what's to come. Thanks thanks for listening to us here at the Big Take it's a daily podcast from Bloomberg and iHeartRadio. For more shows from iHeartRadio, visit the iHeartRadio app, Apple Podcasts, or wherever you listen. And we'd love to hear from you. Email us questions or comments to Big Take at Bloomberg dot net. The supervising producer of The Big Take is Vicky Vergolina. Our senior producer is Catherine Fink.
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