The question on everyone’s mind, “Is recession this year unavoidable?” can thankfully be answered with a simple no in our opinion. That’s the short answer. Of course, the longer, more in-depth answer is a bit trickier. To delve deeper into the topic let’s look at some facts we already know. We know that many of the economic sectors that react quickly to high-interest rates have acted as we would expect. This means they have acted as expected to the tightening efforts of the Federal Reserve (FED). In fact, several investment sectors within the real Gross Domestic Product (GDP) have been in negative territory since 2021.
As one relatable example, real residential investment has been in decline since 2021 with little change. In addition, nonresidential investments in structures have also been in negative territory since the second quarter of 2021. However, they managed to increase slightly into positive territory during the last quarter of 2022. This increase represents a 0.4% improvement on an annualized seasonally adjusted basis. It is fair to say that nonresidential investment in equipment has been hit-or-miss. It has posted three negative quarters since the third quarter of 2021.
What This Means, Good or Bad?
Now that we have gathered that these sectors have declined, what does that mean in terms of the impact it has on the economy? Well, to put it simply, the weakness in investment has so far not been enough to force the U.S. economy into a recession. In addition, we believe that we are close to a bottom-out in terms of investment weakness within this cycle.
We base this prediction in part on how the housing cycle reacts. The housing sector is the most sensitive when it comes to higher interest rate adjustments. This means that this sector will show evidence of an adjustment quicker when facing higher rates when compared with other sectors. There are two more rate increases expected in March and then May, which will likely have some effect on the investment side of the economy. Aside from this, we feel it is close to bottoming out in terms of weakness.
A Look At Personal Consumption Expenditures (PCE)
Another sector that we are basing our look ahead on is PCE, most notably PCE goods. PCE services have continued to expand due to its recovery from the COVID-19-induced recession. Therefore, we feel that any weakness we see during the first quarter of 2023 will likely be related to the weakness or strength of PCE goods and if it continues to improve within the service side of the economy. The good news is that January’s employment numbers as well as ISM Service numbers seem to point to a recovery within the consumption of services sector throughout the first month of the year. Of course, it’s important to continue to pay close attention to next week’s monthly retail and food services report for more indications of how this sector is moving.
What Could Happen?
Of course, there is always the possibility that services consumption will begin to dwindle during the second and third quarters of this year. This is even more likely if interest rates continue to go up. This market correction is likely the result of a slowdown in the consumption of goods based on the immense increase noted throughout the COVID-19 pandemic. It could also be related to a more recent rate of interest increase on savings deposits as well. This increase has been significant, especially after it has remained at a zero rate of interest for decades now.
How The Savings Rate Impacts Consumption and Savings
It’s important to remember that the rate of interest acts as an opportunity for cost savings. In other words, when the savings rate is high, then individuals will often choose to save now and spend or consume tomorrow. The opposite is true as well, meaning that when savings interest dips or is low, then Americans will many times opt to go ahead and spend or consume today and not save. This is what has happened pretty much since the early part of the century since saving interest rates have been close to zero. It makes sense that if Americans feel they are not making any headway with interest rates next to nothing for savings, they might as well spend instead of save.
What Does All This Mean?
To put it simply, the decrease in the PCE sector could mean that the market is just coming back down to normal after a boom with the shutdowns, or it could mean that Americans are giving more thought to consumption or spending— perhaps for the first dime in decades. Likely, it’s a bit of both. Either way, Americans are considering the option of savings instead of consuming now and this is a notable shift. We feel that if there is going to be a recession this year it will depend primarily on the effect the recent increase in interest rate has on savings accounts and current consumption.
The Last Component
Finally, the last component of the real GDP that we feel will impact the likelihood of a recession is the year’s economic performance in the external sector. This is also called net exports. It is real exports minus real imports of goods and services. The last year was a good year for exports, primarily due to the Russian-Ukraine war. As a result of this, the US increased its energy exports considerably. At the same time, imports of goods and services weakened or were reduced, after a strong first quarter. These changes helped to produce a net positive export for the GDP. Unfortunately, the improvement of the energy situation in Europe as well as the appreciation of the U.S. dollar has worked to diminish the impact this component is having on GDP growth. As a result, we actually expect a lower contribution from net exports to growth this year, which could contribute to weaker economic growth overall.
A Change to Our Economic Forecast
We have adjusted our economic forecast for this year and next based on many of the factors outlined above. As we explained previously, the possibility of a soft landing has thankfully increased considerably. However, we do feel a recession is still a possibility for later on in the year. In other words, it’s not a done deal yet. This is based on our experience and the strength we are still seeing in the jobs market.
Second Quarter Outlook
Although our overall forecast has improved, we still see a recession starting in Q2. We do expect the decline in GDP to be milder than we expected before. That means that for 2023 overall, we now expect a growth of 0.5% compared to 0.0% before. We expected growth for 2024 to be 1.1% instead of 0.8%. Both rates will be below the potential output growth of 1.8%. This means that the Fed will still keep inflation lower during 2023 and 2024. Therefore, while these expectations do show signs of a coming recession, it is not inevitable or unavoidable, and it should be better than originally expected.
Any opinions are those of Brockmeier Financial Services, LLC, and not necessarily those of RJFS or Raymond James. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. There is no assurance any of the trends mentioned will continue or forecasts will occur. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of the strategy selected.