Traders work on the floor of the New York Stock Exchange at the opening bell on Aug. 5.ANGELA WEISS/AFP/Getty Images
Call it the economy that doesn’t make sense.
Rarely, if ever, have the standard indicators offered such a baffling muddle of contradictory readings. Some point to still decent growth. Others say a slowdown is looming.
“I’ve been in this business a long time, and I can’t remember any period when economic numbers were telling such different stories,” Nobel laureate Paul Krugman wrote a month ago.
The murkiness has only grown worse since then. Right now, the bond market’s favourite recession indicator, the yield curve, is flashing red. Yet Wall Street has charged higher and higher since mid-June, as investors grow increasingly confident that the giant U.S. economy will escape serious harm.
Oddly, though, as stocks have soared, commodity prices have plunged. The most convincing explanation for this downturn is that investors foresee lower demand ahead for metals and energy because of a slowing global economy.
U.S. yield curve flashing more warning signs of recession risks ahead
U.S. economy contracts, flashing signs of technical recession
Yet it is difficult to detect even a flicker of concern in North American labour markets. In both Canada and the United States, unemployment has shrivelled to multidecade lows as employers eagerly pursue any available worker.
In this unusual economy, even relationships that are true by definition no longer hold true in practice.
Take gross domestic product (GDP), the total value of everything produced in the economy. It is always equal, in theory, to gross domestic income (GDI) – the amount that people get for selling all the stuff they have produced. In official statistics, discrepancies between GDP and GDI are typically minor and the result of trivial accounting differences.
Until now, that is. Real GDP in the U.S. has been shrinking since the end of last year, writes Matthew Klein of The Overshoot newsletter on economics. But GDI, “which is published by the same government agency that compiles GDP, has been growing continuously since the end of 2021.”
The discrepancy between the two readings is a major puzzle for economy watchers. And the frenetic speed at which conditions are flip-flopping doesn’t help clarify the situation.
“In the last 18 months we have seen the fastest global growth in 50 years, followed by the most rapid slowdown,” economic historian Adam Tooze noted in June.
The abrupt shift, he argues, has created an unprecedented global economic configuration in which inflation is rising and growth is slowing at the same time as families and businesses are unusually vulnerable because of sky-high debt levels.
How will this situation end? You don’t have to look hard to detect dark clouds around the globe.
The Bank of England delivered one of its grimmest outlooks in memory this week when it bumped up interest rates by half a percentage point. It warned that inflation will hit 13 per cent by the end of this year. It also forecast that Britain will slide into a 15-month recession.
Granted, Britain is a special case. It is unusually exposed to higher fuel prices and labour costs. It is also exceptionally adept at economic self-harm in the form of Brexit.
Still, the Bank’s sense of impending doom has its counterparts elsewhere. In Canada, analysts are warning the real estate market could chill the entire economy if it continues to slow at its current rate.
“In Toronto and Vancouver, the decline in activity is quickly becoming one of the deepest in half a century,” Robert Hogue, assistant chief economist at Royal Bank of Canada, warned in a note this week. “Prices are sliding fast and the exuberance that permeated these markets is being replaced by fear.”
The U.S. also appears to be skating on thin ice. The yield curve, which measures how interest rates on short-term Treasury bonds compared with rates on their longer-term equivalents, has historically been an outstandingly accurate forecaster of U.S. recessions. When the curve inverts – that is, when short-term rates move higher than their longer-term counterparts – a recession typically follows.
Right now, the yield curve is deeply inverted. Rates on 10-year U.S. Treasuries are substantially below those on two-year equivalents. It would be unusual if this were not the prelude to a recession.
But don’t mention such nasty thoughts to the suddenly exuberant U.S. stock market. Since mid-June, the S&P 500 Index of large U.S. stocks has gained more than 12 per cent.
Investors appear to be practising a new catechism – one that says inflation will fade over the next few months, that any downturn will be minor and that the Federal Reserve will not have to raise interest rates to exorbitant levels to tame runaway prices.
Maybe their faith will be rewarded. The abrupt twists and turns of the pandemic era have created an unusual alignment of contrary forces. Central banks are stomping hard on the brakes, which would usually mean recession ahead. But many households are still awash in pandemic-era cash. Furthermore, just about anyone in Canada or the U.S. who wants a job can find one. To many ears, that doesn’t sound recessionary at all.
A gauge of market sentiment created by JPMorgan Chase & Co. strategists now says the U.S. will likely avert any significant downturn. Its reading of equity, credit and rate markets suggests only a 40-per-cent chance of a recession ahead.
The analysts at Capital Economics agree a recession is unlikely. At Goldman Sachs, they have it down as pretty much a toss-up.
What should investors make of all this? The sanest approach is to call the economic situation what it is – an enigma.
Mr. Tooze framed the situation well in a recent commentary. “In the current conjuncture, if you aren’t puzzled, you don’t get it,” he wrote.
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