Why hasn’t there been a US recession yet?

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Since last summer, the consensus call has been that a US recession is just around the corner. The logic is clear—an aggressive run of Federal Reserve rates hikes should restrict demand and cool growth. Bloomberg’s most recent survey of professional economists suggests 65% expect a recession within the next 12 months.

But the most anticipated recession in recent decades has now become the most postponed for a number of reasons:

Policy is not overly restrictive. The Fed has raised rates by 500 basis points since March 2022, the fastest pace since the early 1980s, but by many measures monetary policy is only moderately restrictive, and it has been that way for less than six months. For example, the real fed funds rate—the nominal rate minus core personal consumption expenditures (PCE) inflation—only turned positive this year. Financial conditions indexes suggest that monetary policy has become less restrictive in 2023.

Meanwhile, based on the federal deficit as a percentage of GDP, fiscal policy has implicitly turned expansionary again over the past six to nine months. Fiscal policy has also had an indirect positive impact on growth this year because of recent industrial policies (e.g., Inflation Reduction Act, CHIPS Act) encouraging private-sector investment.

The private sector is in fundamentally good shape. Household finances, corporate balance sheets, and labor demand are all stronger than is typical leading up to a recession, providing a cushion against growth headwinds. Ratios such as household debt to disposable income or corporate debt to GDP are not stretched—the household debt service ratio remains near a 40-year low of around 9%. Despite tighter lending standards, most companies continue to have good access to credit.

More than 25 million jobs have been created since the current recovery started in May 2020, and according to the JOLTS survey, there are still more than 10 million unfilled positions. Although some prominent companies have announced large layoffs since the fourth quarter, many more businesses still quote their biggest problem as finding workers, and most appear reluctant to shed workers.

The US economy has evolved to become less cyclical. The pandemic has distorted cycle analysis (and made data noisy). During the pandemic, goods demand surged, supporting manufacturing, and then as spending normalized, demand shifted to services. The economy has experienced slowdowns or outright recessions in specific segments as it normalizes from the pandemic, but they are not occurring simultaneously across all sectors. This could keep the economy from experiencing a broad-based recession.

But the economy has avoided a recession not just because services sector strength offsets manufacturing sector weakness, but also because the US economy is dominated by services activity. It constitutes roughly 81% of the total private sector output. The consequence of a shift to being primarily a knowledge-based services economy that is less interest rate- and oil price-sensitive, and more flexible to adapt quickly to shifting demand, is an economy that is less cyclical and prone to recessions, barring adverse shocks.

So, will the postponed recession materialize? Growth is likely to slow further in the second half, but it is uncertain whether the economy will fall into recession. Current growth momentum is strong enough that it is unlikely that a recession starts before late fourth quarter at the earliest, barring an adverse supply shock or credit event. The likelihood of a recession hinges most on monetary policy becoming more restrictive and eventually causing consumer spending to fall. That may take at least two more Fed rate hikes, but there is also the possibility that monetary policy is operating with an extended lag this cycle, and the tightening thus far will be sufficient to cause spending to crack.

For the positive overall narrative to hold together, an “immaculate disinflation” is almost a prerequisite, and from an investment perspective, equity markets are not priced for a recession materializing. With stocks already priced for the near perfection of a soft landing, we see better risk-reward in high-quality bonds over equities. Within equities, year-to-date gains have been concentrated in a small number of growth stocks, suggesting room for catch-up in less expensively valued laggards. And in the event a recession does materialize, it is likely that the more defensive and cheaper parts of the market will outperform.

Read more in the full report: “Why hasn’t there been a recession?” (published 29 June 2023).