A Recession is Coming
Yes, we will have a recession in the United States this year. At least that is my full expectation based on basic economics and some gut sense of how things will play out politically.
First the economics…
US consumer price inflation is now at 8.5%. Inflation has now been high for nearly 12 months. Inflation last April was 4.15%, the highest it had been in 10 years. No one was sure if that was “real” at the time because inflation dropped to near zero during the Covid recession. But then it continued to rise and stayed around 5% all summer, then continued upward.
That it is high and has stayed high for 12 months is important because that’s enough time for people to go a full annual employment cycle. And that means higher inflation should start to be calculated into people’s salaries now and going forward. That raises costs for businesses, requiring them to raise their prices even further.
The first 12 months of inflation might have been “demand pull” in the sense that it was caused by the government pumping spending into the economy and money into people’s pockets, all leading to higher demand. And higher demand always pulls prices up, hence the name.
The next 12 months of inflation will continue to be partially “demand pull” but now, due to rising wages and input prices for businesses, we’ll also see “cost push” inflation as well. That is what results from costs rising and pushing firms to charge higher prices so they avoid losing money. But those higher prices mean more inflation.
Add to that the supply chain problems and the other gas, oil, and commodities price shocks that are just starting due to the war in Ukraine and you have a recipe for more inflation pressure over the coming 12 months for sure.
Producer price inflation was just announced at 11.2%, the largest 12-month increase since 2010. (Data links at the end.)
Producer prices are the prices producers pay for their inputs. So if the cost of most inputs rose by 11% and people are demanding higher wages due to the inflation they are facing, we can be pretty sure that businesses will have to continue raising their output prices soon as well.
Import price inflation is also now up to 12.5%, the largest 12-month increase since 2011.
Import prices again capture mostly input or producer prices because even if they are “consumer goods” being imported, they are imported by a store or distributor who then sells them to a consumer. The rest of the imports are explicitly intermediate goods for production. So again, this is a sign of higher input prices for businesses adding to the pressure to raise prices.
All this inflation will lead to higher interest rates which we are already seeing markets from mortgages to US treasuries. (See my earlier post “How High Should Interest Rates Be?”) This will happen no matter what the US Federal Reserve does although the FED will also raise its policy rate(s).
Higher interest rates are going to have two big effects this year. First, they will dampen consumer and business (investment) spending by making credit more expensive across the board. That will dampen real estate values as demand for new homes declines and likely hit the stock market as businesses see a slowdown. All that also dampens household wealth which leads to less consumer demand. And that is all intentionally done to slow demand and hence price increases (aka, inflation).
Second, higher interest rates will dramatically raise the cost of financing the US government’s existing debts and new deficits. This will make any new spending much more difficult and confirm expectations in the markets that the era of easy government spending is over. All the businesses getting money from government will face tougher times. All the people counting on new government spending or waivers for things like student loan repayments, for example, will also likely see all that dry up. At the very least, higher interest rates dramatically raise the political cost to any spending policy, making any such policy less likely to pass.
The situation we are facing in the United States is not unique. Most other countries in the world are facing exactly the same challenges because they too spent and printed too much money during Covid. Hence they are all facing recessions which lowers demand for US goods as well, reinforcing our slowdown.
And, “when the US sneezes, the rest of the world catches a cold”. That is, the US market is large and important for the exports and hence growth of most countries. So a US slowdown also slows down growth around the world.
The difference this time however is that the US slowdown will also be accompanied by rising interest rates. That’s different because all the recessions of the last 40 years were due to slow downs in demand. Therefore when we entered a recession, the FED was always cutting interest rates to stimulate demand and get the economy growing again. This time, the FED will be raising rates while the US economy slows.
That will be a double whammy for US consumers and for emerging markets. When the large developed economies like the US raise interest rates, it pulls financial capital out of emerging markets causing a capital flow reversal in these countries called a “sudden stop”. The name reflects the idea that the capital that was flowing into these countries and financing investment projects suddenly stops flowing in. Investment funds dry up over night and this sudden stop leads to a recession.
The IMF sees all this and just cut their global growth forecasts in part because of these challenges and in part because of the war in Ukraine adding additional stress.
Conclusion and My Gut
My best guess is that we will have a recession this year in the USA. It will be here by fall. “By fall” means it could be here any time. I have a haunting suspicion that when rate hikes start to cause havoc in Washington, a wide range of markets will hyperventilate and speed up the whole process. We haven’t faced this dramatic a situation in many years. It will be rough and likely turn from okay to bad on a dime.
Producer price inflation: https://www.bls.gov/news.release/ppi.nr0.htm
Import price inflation: https://www.bls.gov/news.release/ximpim.nr0.htm
IMF report: https://www.imf.org/en/Publications/WEO/Issues/2022/04/19/world-economic-outlook-april-2022