I don't have a conclusion in mind, because I haven't figured out what is happening exactly... there's two narratives. The evidence for a soft landing:
(+) GDP growth is strong, far from recessionary
(+) unemployment of 3.5%
(+) wage increases are getting smaller
(+) core CPI inflation has dropped
And the evidence the economy has unresolved problems:
(-) credit card default rate has climbed to the highest in 30 years
(-) most homeowners refinanced at low rates, and can't afford current rates - they can't move
(-) financial conditions have mostly been loose in 2022-2023 (leftover Covid stimulus, SVB rescue, Fed funds rate vs inflation)
(-) employers put off firing workers
Each of the negative items, to me, reflects delaying the pain. Consumers put off budgeting, pushing default rates higher when Covid money runs out. Homeowners put off moving in the hope mortgage rates will fall, while the Fed repeats "higher for longer" Fed funds rates. The 3.5% unemployment rate makes new hires hard to find, and employers avoid firing anyone because they expect the problems are temporary. At this point I suspect pain has been delayed, not cured, but I'm still trying to figure it out.
One of the scenarios I'm thinking about is whether an economic contraction could be asynchronous across different areas of the economy. The mixed signals suggest some areas of the economy are shrinking at the same time as others are expanding. This could mean each sector clears out its excesses while there are never enough sectors going down at the same time to pull the entire economy down into official recession. Unemployment could stay low as workers move from shrinking areas to expanding areas and back again, as various areas of the economy digest rising interest rates at different paces.
During the COVID economy, the goods sector expanded while the service sector shrunk. After case numbers declined, the service sector boomed ahead as consumers pivoted to restaurants and vacations instead of buying stuff. Now consumers appear to be in great shape with the lowest
debt-service to income ratio in the 43 year history of that metric, unemployment about as low as it can possibly be, and pro-consumption tailwinds from a "wealth effect" due to home equity. Of course, it's generally the pre-2021 homeowners with sub-4% mortgages reaping this windfall, while all others face rapidly escalating housing expenses - another inequality. Metrics are so good the Fed's
GDPNow tool has apparently gone haywire, predicting 5.9% growth!
Yet, amid all this good news, S&P500
earnings have fallen since December 2021. The rising probability of more rate hikes comes with a rising probability of more bank failures or issues in the non-bank financial economy. Then there is the looming threat of CRE and a possible housing bubble.
Will healthy consumers buy enough time for the banks and office properties to adjust to new realities and will housing prices stay afloat amid low unemployment? Or will companies under earnings pressure start letting staff go, raising unemployment, and crashing the housing/CRE markets?
Companies must decide: "Do we deal with much higher interest expenses by downsizing and de-leveraging or do we just raise prices?" Rapidly falling inflation and earnings suggests to me that attempts to raise prices have hit a wall of competition and steep elasticity. For example,
retail sales seem to have plateaued or entered a lower-growth phase after April 2022. As longer-term rates go up and inflation falls, companies are watching their cost of capital rise faster than their pricing power.
Consumption is still being stimulated by the surplus liquidity from the COVID economy when people and businesses had to cut spending while they were simultaneously getting checks in the mail and cheap loans. Most of us know this effect will run out someday. Thus it may seem like a bad time to be building up
inventories or making
residential investments and a good time to be deleveraging.
Price hikes aren't working, so companies are under pressure to deleverage and downsize their employees and inventories to restore profits. But that's very hard to justify in an environment of strong economic growth and low unemployment. So maybe they'll make hay while the sun shines and then lay everyone off when recessionary conditions become unmistakable.
The relatively new work-from-home economy may support this strategy. In 2022,
McKinsey reported that about a third of workers were full-time remote working. Most employers of these remote workers don't have to lease, renovate, or maintain office space, pay utility bills, or pay as much for security, insurance, permits, etc. The expense of having employees shifted from a mix of fixed and variable costs to almost all variable costs. That means if remote employees are laid off, there is no empty office building to bleed money until it can be sold a couple of years later. Thus there is less reason for employers to preemptively lay off anyone in preparation to shut down expensive fixed-cost facilities.
Competitors are in the same position, so the bigger risk is laying off workers and then being unable to reacquire them and their market share when the economy returns to growth. Plus, WFH workforces can be scaled more rapidly than office-based workforces because growth is not tied to physical facility work. So maybe now, employers will hang onto their inexpensive WFH workers through the rough patches, or even double down on the WFH model to reduce overhead fixed costs and increase flexibility. The result could be a reduced tendency for severe recessions to happen, because the rationale for layoffs is reduced for a third of workers.
