Can US Skip the Recession?

The most recent labor market data paints a concerning picture of overall weakness. Typically, the effects of changes in interest rates take some time to ripple through the economy. Historically, this lag has been around 18 months. Interestingly, this pattern held true as, precisely 18 months after the initial rate hike in March 2022, we are now witnessing the visible impact this month. The Federal Reserve consistently raised rates throughout 2022, suggesting that the consequences of these consecutive hikes will continue to materialize as the year unfolds.

At this juncture, all major macroeconomic indicators converge on a grim reality: the likelihood of the United States avoiding a recession seems increasingly reliant on a miracle. Key indicators, including US tax receipts, gross domestic income, corporate profits, jobless claims, and bankruptcies, all indicate an imminent weakening of the US economy, with the exception of GDP figures, which continue to exhibit strength. Another significant leading indicator, “the total employees in temporary help services,” which tracks the number of temporary employees in the US, has now fallen to levels reminiscent of previous recessions. Typically, in challenging times, temporary workers are the first to be let go, leading to an overall decline in temporary employment and signaling the approaching end of a business cycle. In the current cycle, temporary employment reached its peak in March 2022, but since November 2022, it has sharply declined. Historical data suggests that by the time temporary employment dropped by 5% in previous cycles, the economy was already in a recession. The question now is whether this time will be any different.

Maintaining robust GDP figures may necessitate an even larger deficit from the Biden administration. With the current deficit estimated to reach 9% of GDP, the question arises: is it feasible for the US government to widen this deficit further in the event of a genuine economic downturn? By running such substantial deficits when unemployment was low, the US government has left itself with limited fiscal maneuverability for times when deficits are truly required.

For those who hold a hopeful perspective regarding the prospect of avoiding a recession, there exists a prevailing notion that can assist in evaluating their confidence. This notion posits that the average GDP decline during recessions typically hovers around 5%. If the government were to proactively initiate an excess spending program equivalent to 5% of GDP, which in the current context would amount to approximately 1.1 trillion USD, it could potentially offset the impact of a recession. Simultaneously, the persistent elevation of interest rates could effectively combat inflation. This scenario paints a picture of a potential miracle—evading a recession through a combination of heightened rates to address inflation and substantial frontloaded fiscal expenditure to avert an economic slowdown. And it appears as if the US government & the Fed are doing exactly that.

In theory, this concept appears promising and suggests the discovery of a miracle solution. However, it presupposes that the severity of any impending downturn can be accurately predicted. What if the downturn proves to be more severe than anticipated, necessitating even greater government spending? In such a scenario, the government might find itself constrained by limited fiscal room to provide the necessary stimulus, exacerbating the fiscal challenges facing the government during the downturn.