Inflation and consumer distress add to concerns that the recession is already here

Trays of beef are on sale in the meat section of a supermarket in McLean, Virginia, June 10, 2022.

Saul Loeb | AFP | Getty Images

The case that a recession is looming over the US grew stronger on Friday, with rising inflation and historic lows in consumer sentiment painting an increasingly bleak economic picture.

As if the 8.6% rise in the consumer price index wasn’t bad enough news, that release was followed later in the morning by the University of Michigan’s Consumer Sentiment Index.

This widely followed indicator of optimism registered a paltry 50.2, the lowest in survey data since 1978. That’s smaller than the depth of the Covid outbreak, smaller than the financial crisis, smaller even than the last spike in inflation. in 1981.

Taken together, the data add up to an outlook that doesn’t bode well for those hoping the US can get around its first recession since the brief 2020 pandemic crisis.

“I wouldn’t be surprised if it started in the third quarter of this year,” said Peter Boockvar, chief investment officer at Bleakley Advisory Group. “You can tell we’re in the middle of it now, in the early stages. Only in retrospect will we know for sure, but that shouldn’t surprise us at this point.”

How long it will take to reach this official recession is a matter of debate that only time will decide. But recent data suggest that reckoning may be closer than many economists are willing to admit.

While consumer spending remains resilient, this has come at the expense of a savings rate that has fallen to its lowest level since September 2008, the month Lehman Brothers crashed to trigger the worst of the financial crisis.

Household net worth in the first quarter fell slightly, the first decline in two years, according to Federal Reserve data released earlier this week. That came as household debt rose 8.3%, the biggest annualized gain since 2006.

The Atlanta Fed is tracking second-quarter GDP growth of just 0.9%. Coming after the 1.5% decline in the first quarter, further deterioration in the current period would trigger a common rule of thumb for a recession – two consecutive quarters of contraction.

A strong labor market has been the main firewall against a downturn, but even that has shown some loopholes lately: Last week’s May non-farm payrolls count, while better than expected, represented the smallest gain since April 2021. week showed the highest level since mid-January.

swinging on the edge

Still, the prevailing sentiment on Wall Street is that the economy still manages to avoid a real recession.

“If you look at these numbers, there’s practically nothing the Fed would say, ‘This is good news,'” said Michael Kushma, director of global fixed-income investments at Morgan Stanley. “I’m still optimistic that with the economy slowing, we can flirt with recession, but we probably won’t get there yet.”

Even so, Kushma acknowledges that “the investment scenario is negative on almost all fronts.”

Indeed, Wall Street is closing out the week amid a flurry of selling that encompasses stocks and bonds, indicating both a likely path of higher interest rates ahead and an estimate that the relatively bullish outlook for corporate earnings is likely not to be. will keep.

Target has served as a canary in the Wall Street coal mine, offering two recent readjustments to its outlook to reflect a weakened buyer, growing inventories and therefore declining pricing power. If these trends increase, the pillar of consumer spending that underpins nearly 70% of the US$24 trillion economy is unlikely to hold.

“More and more corporate ads and earnings announcements (or notices) are reflecting a consumer who is now in a bad mood due to declining net disposable income, and as a result, these consumers are drastically cutting back on spending,” Rick wrote. Rieder, CIO of global fixed income at BlackRock.

Rieder fears that the biggest risk to consumer spending and job creation is that the current wave of high inflation will lead central banks like the Fed to tighten policy too much “and essentially fall into a damaging policy error.”

‘We are in a technical recession’

However, there is a feeling elsewhere that the damage has already been done.

“We’re in a technical recession, but we just don’t realize it,” Bank of America chief investment strategist Michael Hartnett wrote before inflation and sentiment reports hit. Looking at the Atlanta Fed’s GDP estimate, he said the US is only “a few bad data points away from the ‘recession’.”

Fed officials have expressed confidence that they can continue to raise rates without bringing down the increasingly fragile economy.

Following the inflation report, markets priced in at least three consecutive half-percentage-point increases – in June, July and September – and a good chance of one more in November. However, central bankers are unlikely to commit that far, hoping the work done over the summer will be enough to slow the pace of price increases and the need for a more draconian tightening of policy.

“The consumer at the margin won’t be able or willing to continue paying these prices. So we think this introduces a greater stagflationary risk,” said Phil Orlando, chief equity market strategist at Federated Hermes, referring to the term for stagnation of growth combined with high inflation. “From a timing perspective, we don’t have a recession call on the table for this year. Our models are suggesting that 2024 is the most likely recession calendar.”

Still, Orlando said investing in the current environment will be difficult. Federated expects more damage to be done before a possible turnaround in late summer or early fall.

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