Author: Anna Wong, Tom Orlik

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This article excerpts an article from Bloomberg to summarize some key economic data, and makes a subjective judgment on whether the US economy can achieve a soft landing in the next six months.

This article mainly expresses two core points: First, the data that can truly reflect the economic situation are US Treasury yields, unemployment rate, deposits and loans, and oil prices. Second, whether there is a recession or not is a nonlinear problem, which requires us to make a distribution forecast for future data, but people deduce conclusions based on the current known data such as CPI, PCE, GDP, non-agricultural employment, etc., which is a linear thinking logic.

This summer, inflation data has gradually declined, jobs have remained plentiful, and consumers have continued to spend, all of which has strengthened the public and the Federal Reserve's confidence that the United States will avoid a recession. When everyone expects a soft landing, be prepared for a hard landing. This is the experience of recent economic history, and it is a disturbing lesson for the United States today.

Below are six statistics to analyze whether the U.S. can avoid a recession. The data include calls for a "soft landing," U.S. Treasury yields, oil prices, unemployment, deposits and loans.

1. Calls for a “soft landing”

“The most likely outcome is that the economy will be headed for a soft landing.” That’s what Janet Yellen, then-president of the Federal Reserve Bank of San Francisco, said in October 2007, just two months before the Great Recession began. Yellen wasn’t the only one who was optimistic. Surprisingly, calls for a soft landing always rise before a recession.

Editor's note: The gray part of the above figure represents the period of recession, and the bar graph represents the articles or news about "soft landing" in the media. Except for the short recession in 2020 caused by the sudden epidemic, there was not much discussion of recession in the market before that. Before the other two recessions, there were strong calls for a soft landing in the market.

Why is it so difficult for economists to predict recessions? One important reason is that people tend to use linear thinking to predict recessions, but recessions are nonlinear events.

2. Unemployment rate

The unemployment rate is a critically important indicator of the health of the economy. The Fed’s latest forecast is for the unemployment rate to rise from 3.8% in 2023 to 4.1% in 2024, a linear projection based on current data trends that would lead to the conclusion that the U.S. will avoid a recession.

But what if the data suddenly drops sharply during an upward trend? Based on this, Bloomberg built a distribution model to predict the unemployment rate.

Editor's note: The dotted line in the figure represents the unemployment rate predicted by the linear model, the dark yellow represents the distribution range of the unemployment rate at the 68% confidence level, and the light yellow represents the distribution at the 95% confidence level. Therefore, there is about a one-third probability that the unemployment rate will exceed 7%.

The strike by U.S. auto workers has now expanded to about 25,000 workers. A prolonged supply chain shutdown in the industry could have a larger-than-normal impact. In 1998, a 54-day strike by 9,200 General Motors employees led to a 150,000-employment drop.

Soft-landing optimists point out that the stock market has done well this year, manufacturing is bottoming out and the housing market is hot. The problem is that these are the areas that react most quickly to monetary policy. But the most important economic data for recession prediction is the labor market, which typically lags 18 to 24 months. That means the impact of rate hikes on unemployment won’t be felt until late this year or early 2024. What’s more, the Fed hasn’t even stopped raising rates yet.

3. Oil prices and U.S. Treasury yields

One of the most reliable recession warning indicators is the price of crude oil, which has risen nearly $25 from its summer low to over $95 a barrel, because higher prices discourage spending on other discretionary items.

Yield curve: The September sell-off pushed the yield on the 10-year Treasury note to a 16-year high of 4.6%. Long-term higher borrowing costs have already pushed stocks down. They could also tip the housing market into crisis and discourage businesses from investing.

Editor's note: On the left is oil prices, on the right is the 10-year Treasury yield. The editor's analysis below will focus on why rising long-term Treasury yields are the most terrifying signal.

4. Deposits and Loans

The core of the soft landing argument is the strength of household spending. Unfortunately, history shows that this is not a good indicator of whether a recession is imminent, and instead consumers typically continue to buy strongly until a recession is reached.

Moreover, the extra savings that Americans have accumulated during the pandemic, largely from government subsidies, are about to be exhausted, and the debate is over how quickly. Bloomberg calculations show that the poorest 80% of the population now have less cash on hand than before Covid.

In contrast to the decline in deposits, credit card defaults are soaring, especially among young people. Next is the auto loan market, and finally the mortgage market, because mortgage defaults are the most lagging. In addition, there is another data point: student loans. Millions of Americans will start receiving student loan bills again this month, the first time after the end of the freeze in 3.5 years. The resumption of repayments may cut another 0.2-0.3% from the annualized growth in the fourth quarter.

What's more, the credit crunch has only just begun. Here's a lending indicator that has a very early warning signal: the Fed's survey of senior loan officers at banks, known as SLOOS.

The latest data shows that about half of large and medium-sized banks are adopting stricter standards for commercial and industrial loans. This is the highest proportion since the 2008 financial crisis, except during the epidemic. The impact will be felt in the fourth quarter of this year - when companies cannot borrow easily, it usually leads to weaker investment and hiring.

Interpretation: The inevitability of recession from the perspectives of unemployment rate, deposits and loans, and US Treasury yields

1. The strong calls for a "soft landing" do not support the conclusion of a recession

When discussing whether the United States will experience a recession on social media, an interesting phenomenon emerged: optimists said that everyone believed a recession was going to happen, so could it still happen? Pessimists also expressed the same view.

This is a typical confirmation bias. When you have a preconceived conclusion in your mind, you will involuntarily look for evidence that supports this conclusion. Therefore, optimists see that the public voice is that a recession will occur, and they feel satisfied that everyone is drunk and I am the only one who is awake; the same is true for pessimists.

So does everyone think a recession is going to happen or does everyone think it won’t happen? I prefer to look at the data rather than my feelings. Bloomberg’s data shows how popular the calls for a “soft landing” are right now.

But I am not quoting this article to say that the public is too optimistic and so a recession is bound to happen. On the contrary, I think the more optimistic the public is, the more conducive it is to economic recovery. The reason is simple. This is the economy, not stocks. "When others are panicking, I am greedy, and when others are greedy, I am panicking." This is the logic of stock speculation, not the logic of economic development. For a country that is dominated by consumption, economic development is very dependent on the confidence of the people. The more confident the people are about the future, the more likely it is that consumption will remain strong, and the less likely the economy will decline.

So I don’t buy the first statistic in this article. So why do I still think a recession is coming?

Because what the American people lack now is not confidence, but money!

2. Unemployment rate, deposits, and loans are the underlying logic leading to recession

There is a point in this article that I strongly agree with, that is, recession is a nonlinear event, and we cannot use known data to draw a linear conclusion. The reason why optimists believe that US consumption is very strong is based on current data such as non-agricultural employment and household consumption expenditures, but based on historical experience, US residents' consumption will remain strong until a recession occurs.

What data can really predict future consumption levels? Unemployment rate, deposits, loans! A person's money is either earned, saved, or borrowed. If all three sources are decreasing, what reason do we have to believe that consumption will continue to remain strong?

This is also what I think is the greatest value of this article, which succinctly explains the underlying logic of the recession. Among them, the unemployment rate data and deposit data shown by Bloomberg have a shorter time span, so the editor quoted the following figure as a supplement. It can be seen that the unemployment rate of American residents has begun to rise sharply, and there is little deposit left.

Consumption accounts for more than 80% of the US GDP. Now 80% of US residents have less cash on hand than before Covid, bank loans are tightening, and loan default rates are rising. In this case, once the unemployment rate starts to turn upward, a recession will be inevitable.

The surge in oil prices may very well be the last straw that breaks the camel's back for consumers.

3. U.S. Treasury yields

The yield difference between the 10-year and 2-year U.S. Treasury bonds is a well-known leading indicator of recession, but its underlying logic is not as intuitive as the unemployment rate and other data mentioned above. And because it is a leading indicator, the U.S. economy is usually very strong when the yield inversion is formed, and this strength often continues until the inversion ends. This is why every time the inversion is about to end, people always forget the lessons of history and think that this time is different from the past.

The same is true this time. The interest rate inversion occurred in April and July 2022 (it was only a short-term inversion in April, but it has been a long-term inversion since July), and it has been more than a year. So we will find that the market's concerns about interest rate inversion are far less than a year ago, and people are beginning to believe that this time is different from the past.

However, the fact is that the economic situation during the process of resolving the inversion is not only not better than in the past, but worse.

The current fiscal situation in the United States is showing signs of deterioration, with the fiscal deficit reaching $1.5 trillion in the first 11 months of fiscal year 2023, a year-on-year increase of 61%. Therefore, continued debt issuance has become inevitable. After the debt ceiling was relaxed in early June, the U.S. Treasury Department added a net debt of $1.7 trillion in just four months. As of October, the total federal government debt has exceeded $32 trillion (including debt held within the government), and the new scale this year is more than $2 trillion.

This debt volume is far from comparable to that in 2008. The two major U.S. debt holders at that time, Japan and China, are now either unable or unwilling to take on such a huge debt. Therefore, there is a serious lack of buying in the U.S. debt market, resulting in a decline in U.S. debt prices and an increase in U.S. debt yields. This is why we have seen the 10-year U.S. Treasury yield rise continuously since July, causing the long-term and short-term interest rate spreads to turn upward.

The reason why I think the background of this inversion is even worse is that the historical inversion was achieved by lowering short-term bond yields, that is, by cutting interest rates. As long as the Fed starts to cut interest rates, short-term bond yields will immediately turn downward. This method at least stimulates economic recovery. Although a recession eventually occurred, at least the recession did not last very long.

However, the lifting of the inversion was achieved by raising the long-term bond yields. The long-term bond yields reflect the market's long-term expectations for US interest rates, and their upward trend means that the market's expectations for the Fed to maintain long-term high interest rates are heating up. In the economic field, the 10-year US Treasury yield is often praised as the anchor of asset prices. Since it plays the role of "denominator" in the asset valuation process, its rise is bound to trigger a decline in the valuation of other assets. Since July, its soaring trend has triggered a series of downward trends in the stock market and the currency market. If the market expects the Fed to maintain high interest rates for a long time, then this downward trend may be difficult to stop.

More importantly, long-term bond yields represent the degree of debt risk in the U.S. A surge in long-term bond yields indicates that the possibility of a debt default in the U.S. is rising sharply.

If you want to lower the yield on long-term bonds, you have to find more buyers. There are only two ways to increase buyers: one is to continue to maintain high interest rates to attract more funds to buy government bonds; the other is to expand the balance sheet, accelerate the printing of money, and continue to borrow new debts to repay old debts.

If the second option is chosen, it will be like drinking poison to quench thirst. The new scale this year will most likely exceed 2 trillion, equivalent to a 6.5% increase in the total debt scale. If this continues, the scale of debt will soar exponentially. The final result is that no economy will be able to take it on, and it can only watch it spiral until the debt defaults.

This is why I think the Fed will not cut interest rates in the short term, because only by maintaining high interest rates can it attract more funds to buy government bonds without further increasing the debt scale, so as to avoid debt default. Debt stability and dollar stability are closely related. Once the debt collapses, the dollar will lose its credit foundation, and once the dollar collapses, the foundation of the United States will be shaken.

When it comes to issues concerning the national foundation, economic recession seems less important. After all, the United States has experienced recession more than once or twice, it’s just that this time it lasted longer.

Summarize

This article borrows an article from Bloomberg and focuses on four data that I believe can effectively predict future economic conditions: unemployment rate, deposits, loans, and U.S. Treasury yields.

Among them, unemployment rate and deposits and loans predict future consumption. Because consumption accounts for 80% of the US GDP. At present, the deposit level of US residents has dropped to the level before the epidemic, second only to 2007. The credit card default rate and bank credit tightening have also reached the highest level since 2007. Most importantly, the unemployment rate data has begun to turn upward.

Therefore, it is likely that U.S. household spending will drop sharply in the coming year.

Finally, based on the current debt situation in the United States, it is speculated that the Federal Reserve is unlikely to cut interest rates in the short term, and thus it is concluded that the recession is not only inevitable but may also last longer than in the past.

This is a big test for global risk assets. Judging from the growing calls for a "soft landing", it can be seen that risk expectations have not been priced in.