Key Questions: Will the Current Recession End Before the Next One Begins?
The economy appears to be experiencing a transition from rapid recovery to mid-cycle/ moderate growth. The Delta variant is a risk, but as long as fatalities do not materially rise, economic repercussions should be limited.
In the early part of the last century, two leading figures in business and economics were at loggerheads over the economic issue of the day: income distribution and what constituted “a fair wage.” Compounding their state of frustration was the fact that little data existed to measure economic activity and assess how the economy was performing. To address this challenge, the National Bureau of Economic Research (NBER) was formed.
NBER comprises more than 1,500 affiliated researchers committed to conducting rigorous economic-related analysis and sharing their findings while intentionally avoiding making policy recommendations or judgments about policies. This independence has earned them a reputation as the official and impartial scorekeeper of the economy. Such a distinction was fortified when a formal “Business Cycle Dating Committee” was created several decades after NBER was founded.
Business cycles have long been a focus of NBER. In 1927, NBER’s inaugural research director published a seminal economic text, Business Cycles: The Problem and Its Setting. But the Business Cycle Dating Committee brought NBER greater prominence as many business leaders, policymakers, and academicians now look to NBER to declare when economic expansions and contractions (i.e., recessions) begin and end.
In determining when economic expansions and recessions begin and end, NBER relies on a multitude of variables, with employment and real (after inflation) gross domestic product (GDP) among the most significant. NBER assesses not only the level of these indicators but also the rate of change from period to period, the duration of the change, and the magnitude and breadth of the change.
Thirteen months ago this week, the Business Cycle Dating Committee of NBER issued a report stating that the economic expansion that began in June 2009 had ended in February 2020, marking the expiration of the longest economic expansion on record dating back to 1854. The fact that NBER chose to date the recession several months after it began is standard practice. For instance, in December 2008, NBER declared that a recession began twelve months earlier. Furthermore, NBER’s decision to establish the beginning of the recession in February of last year is intuitive to most: It coincided with many industries experiencing steep and abrupt declines as policymakers imposed severe restrictions and lockdowns in an attempt to limit the spread of the coronavirus.
Since that time, however, NBER has not issued a new statement indicating that the recession has ended. It could do so at any time, and we think it inevitably will. But will the current recession be declared to be over before the next one begins? We believe it will be, but one large unknown still lingers.
In the period between NBER’s declarations of expansions and contractions, investors look to countless indicators to discern the strength and future direction of the economy. Perhaps none is followed more closely than the interest rate on long-term US Treasury bonds, and it is indeed worth monitoring now.
Over the past year, the yield on the 10-year US Treasury bond rose from a pandemic-induced low of 0.54% in March 2020 to 1.74% by March 2021, a signal that economic activity was recovering and inflationary pressures might be building. More recently, however, long-term interest rates have declined at a rate of change that is causing some to posit that the narrative of robust economic growth and rising inflation may be reversing. Quoting one respected financial journalist: “The bond market has swung in ways that suggest a period of slower growth and more subdued inflation could lie ahead.”
Such a phenomenon – slower growth and tame inflation – has been somewhat borne out in recent economic releases. The unemployment rate and new claims for unemployment insurance both rose on a period-over-period basis; growth in auto and home sales has moderated, and estimates for second-quarter GDP have trended lower. Similarly, expectations for inflation have declined from 2.4% to 2.1%.
That said, some perspective is needed: The increase in unemployment was only 0.1%, unemployment claims still hover near pre-pandemic lows, auto and home sales are still around near record highs, GDP is expected to grow 7-8% in the recent quarter (down from 9-10% projected previously), and at 2.1%, inflation expectations are “Goldilocks-like” (not too hot, not too cold), although such expectations often prove fleeting and can change quickly and higher inflation could pose some risk to stocks if it rises faster than anticipated.
The point I’m trying to make is that what the economy appears to be experiencing is a transition from a rapid “V-shaped” recovery to a mid-cycle/moderate growth phase. And while transitions may cause some turbulence for equities and other risk assets, they need not spell turmoil.
One unknown risk is the new Delta variant. Positively, given the high level of vaccine compliance in the US, renewed COVID-related risks seem manageable, and we are hopeful this trend continues. Globally, however, cases are rising, especially in parts of Asia. But here, so long as fatalities do not rise, the most severe economic repercussions are likely behind us.
Again, we are hopeful this trend continues as well. In the meantime, we will continue to maintain a bias toward risks assets as we await the official arbiter of the economy to confirm that the COVID recession has ended and a new expansion is underway.
For more information, please contact your Key Private Bank Advisor.