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U.S. Recession: 'Pessimist Bulls' Are In For A Shock

February 17, 2023
minute read

Following a recent round of economic data that came in stronger than anticipated and sparked additional hawkish Fed buzz, stocks appear to be closing the week on the defensive.

Anatole Kaletsky, chairman and chief economist of Gavekal Research, refers to investors who are "cautiously pessimistic because they foresee an early U.S. recession" as "pessimistic bulls," and this is not a good scenario for them.

In fact, he continues, they are "wildly positive" because they believe that any economic slowdown will quickly reduce inflation, enabling the Federal Reserve to begin lowering interest rates by the summer. This will then cause bonds and stocks to rebound to levels seen prior to Russia's invasion of Ukraine.

Sadly for this tribe, Kaletsky believes that a U.S. recession in the near future is virtually impossible, and that the economy is more likely to accelerate later in 2023.

Following are his top ten arguments for why he thinks this is the case. Given the length of the list, it is necessary to display portions of Kaletsky's content in bullet points.

  1. A U.S. recession has never started in the post-war era with real interest rates that are extremely negative across the yield curve. This period of monetary tightening is still the mildest in any cycle since the 1950s if we concentrate on the level of interest rates rather than the rate of change.

  1. Even after the Fed funds rate reaches 5%, real long rates will continue to be negative. Because of how highly inverted the U.S. yield curve is, real long rates will continue to be negative even if inflation falls below 5%, barring a quick disinversion of the curve. Neither of these occurrences is probable in the upcoming months.

  1. Inversion of the yield curve is not a reliable recession indicator. All U.S. recessions since 1970 have been preceded by inversions, however there have been a number of inaccurate or extremely early forecasts (in 1966, 1978, 2006 and 2019, unless you believe that COVID came from Wall Street, not Wuhan).

  1. The US job market is too robust for a downturn.

  1. Even though average real salaries have decreased, overall real income has increased. Since "rapid employment growth has more than compensated the decline in real wages," this is the case.

  1. Real wage growth will shortly resume its upward trend. With the still-extremely tight labor market, pay growth should remain around 5% for the upcoming few months but price inflation should decline to below 5%, barring another oil shock.

  1. Due to government COVID subsidies and reductions in consumption during lockdown, the stock of personal savings is remains much above average. The amount is typically estimated to be between $1 and $2 trillion, or between 5% and 12% of household spending in the United States.

  1. Currently, housing is stabilizing. The 30-year mortgage rate is currently lower than it has ever been in American history, prior to the housing bubble of 2004–2007.

  1. Services are becoming more popular than products. Smaller improvements in the considerably larger service sectors offset substantial losses in the industrial sector. The economy is still expanding as a result.

  1. If a moderate U.S. recession occurs this year, as most investors now anticipate, it will demonstrate that Goldilocks, the Magic Money Tree, and "immaculate disinflation" are real economic concepts and not just fables and fairy tales. A U.S. recession in 2023 is "too good to be true." If so, we will all need to reevaluate our preconceived notions of fiscal responsibility, prudent monetary management, and challenging political trade-offs.

In summary, Kaletsky believes there won't be a recession. This suggests that the timing of the Fed's monetary policy easing this year is not the fundamental question. The question is whether the Fed would opt to significantly tighten more during the summer or tolerate permanently higher inflation, both of which would cause a second decline in bond and equities prices, according to Kaletsky.

With S&P 500 futures ES00 down 0.7%, stocks were expected to continue their downward trend from Thursday. Ten-year Treasury rates increased by 3.8 basis points to 3.900% as investors' concerns about inflation staying high persisted. Although gold GC00 lost 1.1%, the dollar index DXY increased by 0.6%.

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