Is this a Recession?

For months now, economy officials have been sounding the alarm on a recession in the near future. Rising interest rates, a war in Europe, turmoil in the energy markets, and persistent supply chain issues have created a perfect storm for the economy. The US GDP has already shrunk this year, decreasing by 1.6% in the first quarter of 2022. But it doesn’t feel like a recession. Inflation reached a new high in June of 9.1% and the labor market is strong, with unemployment steadily decreasing over the past year and wages growing at a rate of 6.7%. What’s going on?

The Case for a Recession

The recession camp has a pretty strong case, for a few main reasons.

1. Geopolitical volatility (and energy volatility). The Russian invasion of Ukraine has added strain to the European economy as they take in millions of refugees, which could affect the United States in today’s interconnected global economy. Strained relations with Russia have led to bans on oil imports to Europe from Russia, with a ban on seaborne imports of Russian crude oil taking effect on December 5, 2022. This comes at a time when energy markets are very volatile. The OVX, a crude oil volatility index, is up 30.66% YTD. High oil prices typically precede recessions, and oil prices are particularly high right now. 

2. Monetary Policy. The Fed is aggressively hiking interest rates in an attempt to cool inflation, and high interest rates could quickly slow down the economy, plunging it into a recession. As interest rates have risen, bond prices have fallen and bond yields have risen on short-term bonds. Long-term bonds, on the other hand, have relatively lower yields. This describes the Inverted Yield Curve, where the yields on short-term bonds are higher than the yields on long-term bonds. This is another recession signal because by having lower yields on long-term bonds, the bond market is saying that the long term outlook is poor.

3. Dr. Copper. “Who is Dr. Copper?” you may ask. They have a Phd in economics and is a pretty good indicator for recessions. They’re not an actual doctor, it's just copper. Copper is a solid economic indicator because the substance is used in many sectors of the economy. When copper prices go down, that means there is less demand for copper, which typically signals less overall demand in the economy. And copper prices are waaaay down, specifically 27% down since March of this year. Not a good sign.

The inverted yield curve. As a bond gets more mature (longer time period) you get less interest for owning it.

To top it all off, persistent supply chain issues from the pandemic are making it difficult for producers to make and sell their products, a major problem for the economy. However, there is a glaring neon sign that there is no recession coming: the labor market.

Robust Labor Market

The labor market is incredibly strong right now. In a recession, unemployment should be rising and wages should be falling, but the opposite is occurring. Unemployment is the lowest it has been in 50 years and wages have been rising rapidly, though that growth is beginning to slow down. This can partially be attributed to a record high 11 million job openings. With companies desperate to fill those jobs, they are willing to hire nearly anyone (hence the low unemployment) and pay higher wages to entice workers. Job openings have been increasing over the past decade because boomers have been retiring in droves, leaving a smaller labor force behind. This trend was exacerbated by the pandemic; as people received stimulus payments from the government, they wondered why they should work for little pay when they can just live off stimulus. To give you a frame of reference for just how much the pandemic affected job openings: job openings doubled from 2010 to 2020; they doubled again from 2020 to 2022. 

This situation is unsustainable. GDP is decreasing but companies are still hiring as many workers as possible. One of two things has to happen: companies keep hiring workers, the economy adjusts with GDP increasing, and we avoid a recession - or GDP continues decreasing, companies realize that they need to layoff workers, and a recession officially begins.

Stagflation?

There is another possible outcome for the economy: stagflation. Stagflation is the economist’s nightmare scenario, an economic affliction in which the economy experiences both high unemployment and high inflation. Usually, high inflation is correlated with low unemployment and low inflation correlated with high unemployment. Having the worst parts of both situations (high unemployment and high inflation) is a very unfortunate situation to be in. The last time the United States experienced stagflation was in the 70s, which was caused by oil embargos and loose monetary policy. We aren’t currently in stagflation because unemployment remains low, even though GDP is shrinking and the economy is slowing down (which is strange to say the least).

The Soft Landing

If stagflation is the nightmare scenario, this is the golden scenario, in which inflation is brought down without causing a recession and the economy returns to some semblance of normalcy. With every day that passes this outcome seems less and less likely, but we can still hope. The main factor that could cause this is the record profits corporations currently have. Corporate profits have increased by 41% since the pandemic, and the hope is that the extra money will provide a buffer against an economic downturn, should one occur. For example, the extra money may be able to prevent layoffs as corporations are able to afford the labor costs with the extra profits.

Where the economy is heading is anyone’s guess. A global recession unfortunately does seem likely given the unstable state of our world. A recession should at least cool inflation, which is a good thing. Hopefully it isn’t too severe when it arrives.