Records and Recession Risks

Episode Summary

Executive Summary: The episode centers on rapidly rising recession risk amid high inflation, aggressive Fed tightening, and still-solid but potentially weakening consumer and business fundamentals. The guests debate whether the U.S. can avoid recession through 2023, with estimates ranging from 40% to 75%, and conclude that oil prices, Fed policy errors, and consumer pullback will largely determine the outcome.

Main Topics: Recession risk and probability assessments (Priority: 5/5): The hosts and guest debate whether the U.S. economy is heading into recession by the end of 2023, with views ranging from cautious optimism to high conviction that a downturn is likely. Federal Reserve tightening and policy error risk (Priority: 5/5): A major theme is whether the Fed can normalize rates and shrink the balance sheet without overshooting, especially as markets expect rapid hikes and quantitative tightening. Inflation, wages, and consumer spending (Priority: 4/5): The conversation links inflation to real income erosion, slower consumer spending, and possible shifts in the wage-price relationship. Labor market strength versus hidden fragility (Priority: 4/5): Despite recession fears, claims data and job growth remain exceptionally strong, complicating the case for an imminent downturn. Commodity shocks, food prices, and the Ukraine war (Priority: 4/5): The Russia-Ukraine conflict is framed as a major driver of food and energy inflation with global spillovers and recession implications. Indicators used to signal recession (Priority: 3/5): The group compares the usefulness of the yield curve, jobless claims, consumer confidence, and the unemployment rate as recession signals.

Key Arguments: Michael Strain argues recession odds are about two-thirds by the end of 2023, driven by weakening consumer demand, weaker business investment, and a likely Fed policy mistake. Strain says inflation is eroding purchasing power, so consumer spending should slow as demand reasserts itself, especially under higher food, energy, and borrowing costs. Chris Varides places recession odds around 55%, raising his estimate because inflation expectations have worsened after the Russia-Ukraine shock and because the Fed may over-tighten. Ryan Sweet is the most bearish, assigning a 75% recession probability and emphasizing that the Fed appears hell-bent on inflation control and is likely to make a policy error. Mark Zandi argues the U.S. economy still has strong buffers: low leverage, strong corporate profits, high asset prices, and excess savings, making recession less likely in the baseline. The group agrees that if recession arrives, it is likely to be mild rather than a deep financial crisis or pandemic-style collapse. The participants debate the Fed’s best tool mix, with Strain favoring more aggressive quantitative tightening and less reliance on rate hikes because QT would cool housing without as much shock to the real economy. Consumers with lower incomes and lower credit scores appear more stressed and may already be drawing down savings to meet necessities, while higher-income borrowing looks more travel- and spending-related. Oil prices are treated as the key swing factor: sustained high or rising oil prices could push inflation expectations higher and tip the economy into recession.

Data Points: Goods trade deficit: $107.5 billion - Ryan’s statistic of the week; used to explain a large drag from net exports on Q1 GDP. Overall trade deficit: $89.2 billion - Recent monthly trade deficit expected to shave 1.5 percentage points off Q1 GDP growth. Q1 GDP tracking estimate: 0.7% annualized - Current tracking estimate discussed after the trade data. Probability of negative Q1 GDP: 25% - Mark Zandi’s estimate given trade and inventory uncertainty. Average hourly earnings growth: 11.8% year over year - March wage growth statistic in leisure and hospitality, cited as evidence wages can keep up with inflation in some sectors. UN FAO food price index monthly change: 12.6% - March increase in global food prices, described as the largest gain in the data series. UN FAO food price index yearly change: 34% year over year - Food price inflation across cereals, oils, dairy, meats, and other categories. Initial jobless claims: Lowest since Thanksgiving week 1968 - Weekly claims data underscoring extraordinary labor market tightness. Four-week average initial claims: 170,000 - Described as the lowest on record or near-record low in the discussion. Excess pandemic savings: $2.5 trillion to $2.6 trillion - Estimate of household savings above the pre-pandemic trend. Federal funds rate outlook: 2.5% by no later than next year - Market-implied and discussed as the likely path of Fed tightening. Terminal funds rate expectation: Closer to 3% - Market pricing discussed for a possible peak policy rate. Current 10-year Treasury yield outlook: 3.5% to 4% - Mark’s illustration of normalized long rates under tighter policy. Mortgage rate outlook: 5.5% to 6% - Expected mortgage rate range if policy tightens as projected. Recession probability estimates: 40%, 55%, 66%, 75% - Mark, Chris, Michael Strain, and Ryan respectively gave their own recession odds through end-2023. Consumer confidence benchmark: Lower today than during lockdowns - Mark noted sentiment is now worse than during the pandemic shutdown period. Oil price reference: About $100 per barrel - Used as the key threshold in the discussion of recession risk and inflation pressure.

Pivotal Quotes: "I would put two-thirds probability of recession over the next 18 months." — Michael Strain: His headline assessment of recession risk and the basis for his warning about consumer, business, and Fed-related weakness. "I think the severity of the next recession will be mild." — Chris Varides: His view that fundamentals remain strong enough to prevent a deep collapse even if recession occurs. "The Fed just fell extremely behind the curve over the course of 2021, I'm becoming increasingly worried that they are going to make a symmetric mistake in 2022." — Michael Strain: His central policy concern that the Fed may overreact after underreacting to inflation.

Implications: Listeners should expect more Fed tightening, volatile markets, and a rising chance of a mild recession by late 2023. Watch oil prices, consumer spending, and jobless claims most closely; these likely determine whether the economy slows safely or tips into downturn.