Does the Data Cry Recession?

The bearish economic narratives just won’t loosen their grip. Yet while fears of a growth slowdown and recession are running rampant, the data is telling a different story. Yes, the trend for growth is certainly lower, normalizing from the post-pandemic inflationary boom – but that normalization is proving not to be a straight line. We saw the effects of noise in the first half of 2022, as net exports and inventories dragged headline growth into negative territory despite domestic demand holding up. And while those methodological quirks have faded, the economy has broadly proven to be remarkably resilient and less rate-sensitive than many assumed.

Housing Dynamics in Flux
We keep hearing about the variable lags of monetary policy – that the data needs time to catch up to higher interest rates. While that’s true for some areas of the economy, in other areas the lags have been very brief, and tighter policy has been extremely effective at reducing demand. Just look at the housing market, which for all intents and purposes has been broken by higher mortgage rates:

• Existing home sales are at their lowest levels since 2012, outside of the brief pandemic lows.
• New home sales are back to 2017 levels.
• Mortgage applications are nearly undercutting their lowest levels since the Global Financial Crisis and are basically back to 1995 levels.

You can’t break it twice, and that means housing could very well flip from a huge growth detractor to a marginal tailwind. As rates have stabilized, demand intentions have bounced back. This suggests there is plenty of pent-up demand for home purchases should rates come off their highs – and that’s more growth in the pipeline. And don’t forget those golden handcuffs: Residential spending is shifting from new construction to renovation and remodeling as homeowners are locked into their homes with low mortgages.

U-Turn for the Auto Sector?
On the topic of shifts, a critical component of the industrial sector – auto manufacturing – is set to become a major tailwind for industrial production. Supply chain constraints are finally easing in the auto sector and the result is a rapid pick-up in new car sales which posted their highest levels since January as of the end of October. At that run rate, autos alone would contribute 1.5% to fourth quarter GDP. And with inventories still 33% below the pre-pandemic trend, there’s considerable room for increased production to further fill in that inventory hole.

Consumption Is Holding Up
Corporate capital expenditure intentions may have fallen, but investment continues to power higher, holding steady at a clip of 10% year over year. And finally consumers, the core driver of the US economy, continue to do what they do best – spend. Consumption remains robust, and while spending patterns have clearly shifted towards services, goods consumption continues to hold up, as both credit card and retail sales data has shown. Most importantly, while nominal consumption continues to push higher, its composition appears to be shifting back from price toward quantity as inflationary pressures in goods continue to fade. Nominal growth driven by real growth and not prices is exactly what we want to see.

So What About That Recession?
If everyone thinks a recession is coming, does that perhaps make it less likely if we haven’t seen it by now? We’ve all heard that the fear of recession can be a self-fulfilling prophecy as the process of firms preparing for recession eventually slows growth… to the point of recession.

With recession fears as prevalent as they’ve been in 2022, what if that process of battening down the hatches has already happened? If growth remains resilient and a recession doesn’t materialize, it could set off a positive feedback loop of catch-up by firms that had been preparing for the worst. While this would be problematic for a Federal Reserve that is keenly focused on bringing growth back below trend, it also lends credence to the underappreciated outcome of a soft landing if disinflationary forces continue to filter into the hard data.

Consensus says the Fed is looking in the rearview mirror, recession is a certainty, and earnings are far too optimistic and need to come down, driving markets lower. But what if consensus is wrong?