Will There Be a Recession in 2022?

The year 2022 has produced a laundry list of risks that have challenged markets, including war in Ukraine, rising commodity prices, decelerating growth, stubbornly high inflation, and the Federal Reserve’s (the Fed’s) shift to more hawkish monetary policy. Against this backdrop there has been an understandable amount of speculation about whether the Fed can engineer a soft landing and avoid a recession. We aim to look at a variety of economic data to get a sense of whether a recession is likely over the coming twelve months.

The Conference Board Leading Economic Indicators
The Conference Board Leading Economic Indicator Index tracks ten economic metrics that tend to be early indicators that a recession may be near. Figure 1 is a summary of these indicators showing:

• The average lead time and magnitude of deterioration we typically see in advance of recessionary periods
• Number of months since the most recent peak
• How much the indicator has weakened since the peak

While we are seeing weaknesses in a handful of leading indicators such as consumer expectations for business conditions and new orders for consumer goods & materials, these metrics likely reflect the impact of recent inflation on consumer sentiment and willingness to spend. Other metrics, such as new orders for nondefense capital goods, have barely come down off their recent peaks as businesses continue to increase capex spending to invest for the future. At the NBER composite level, we have seen only a slowing of the rate of increase but have still not started to come off the post-Covid peak.

Checking in on US Households
The consumer is an important component of the US economic engine – roughly 70% of our nation’s GDP is driven by consumption. If we are to slip into a recession, we likely need to see some vulnerability in US household balance sheets. Let’s start by reviewing household savings.

We calculated a cumulative excess savings rate – the running total of the monthly amount households save above current trend – going back to 1985. We decided to calculate excess savings from 2020 to present using the savings trend as of 12/31/2019, as Covid was such an unusual event that we felt it distorted the true savings trend over the last couple of years. This cumulative excess savings metric gives us a good sense of whether households are drawing down on their normal level of savings or accumulating more. It stands to reason that if households are drawing down on their excess savings stockpile, then balance sheets are weakening, and households are feeling less secure about their financial prospects – a potential headwind for consumption. If you look to the early 1990s, early 2000s, and 2008 recession, cumulative excess savings began to fall two to four years before the actual downturn began (Figure 2). Looking at the current situation, we have an eye-popping $2.5 trillion of excess savings built up, which is roughly 15x more than the previous peak in 2013 (Figure 3). From this perspective, there are still plenty of savings to draw from to power consumption going forward.

Figure 2 – Cumulative Excess Household Savings (1/1/85–12/31/19)

Source: Federal Reserve Economic Data (FRED)

Figure 3 – Cumulative Excess Household Savings (1/1/85–2/28/22)

Source: Federal Reserve Economic Data (FRED)

What About Household Debt?
Another metric to highlight is a household’s debt service payment relative to their disposable income. This is referred to as the household debt to disposable income ratio. If this ratio moves higher, households are spending more of their disposable income to service their debt, which can be a sign of financial stress. It turns out that this ratio has been hovering around 40-year lows recently, at a little over 9% as of 9/30/2021 (Figure 4). Compare that to 12%–13% in the years leading up to the early 1990s, early 2000s, and 2008 recessions, and it appears that households are in a significantly better financial position to service their debt.

Figure 4 – Household Debt Ratio Is Manageable (1/1/85–9/30/21)

Source: Federal Reserve Economic Data (FRED)

We have two takeaways given this data. A recession in the next 12 months looks much less likely when household balance sheets are this healthy. Consumers have plenty of cash and room to re-lever, which can fuel spending going forward. Another takeaway is that if we were to slip into a recession, the cushion that households have built up should make for a much shallower downturn than the last few we’ve experienced. We don’t have the excesses we had in prior cycles.

Should we Look to the Mid-90s as a Road Map?
Markets tend to fear Fed hiking cycles, and understandably so, as it has been the typical experience that most tightening periods precede recessions. However, this is not always the outcome, as evidenced by the mid-90s hiking cycle (Figure 5).

Figure 5 – Historical Fed Hiking Cycles

Source: FactSet

During the mid-90s, the Fed engaged in tightening that was relatively aggressive but did not lead to a recession. Comparable to what we are seeing in the leading indicators right now, manufacturers’ new orders for consumer goods & materials and consumer sentiment both declined materially at the early phase of the cycle. But many other indicators did not follow the same trend, and ultimately the Fed was able to engineer a soft landing.

It is too early to tell how this Fed hiking cycle will play out. But a current read of the data in a historical context certainly leaves open the possibility that this cycle may ultimately look more like shades of the 1990s than shades of the 1970s.