The former Bank of England MPC member Danny Blanchflower ever released a piece of research suggesting that the U.S economy was entering a recession.
Many would have scoffed at that idea. But it is worth looking at this through the lens of the provisional November University of Michigan consumer sentiment survey that was released on Friday. This is because the survey includes a question for consumers about their perceived personal finances over the coming year which, according to Blanchflower is a good guide to recession probability. It is certainly true that this measure did slump in the provisional November release, and on top of prior weakness, but does this suggest that the US could enter a recession, or might already be in one as Blanchflower claims?
Mr. Steve Barrow, Head of Standard Bank G10 Strategy, is skeptical that the US is entering into a recession right now but would certainly not dismiss the idea that there could be one coming in the not-too-distant future if things don’t go the way that policymakers plan. The justification for this lies mainly on two fronts: Firstly, that people are still too scared to re-engage properly because of Covid and, secondly, because surging inflation is making consumers very nervous about their inflation-adjusted personal finances in the future. The former, of course, is new because we’ve not lived through a pandemic before. But we have lived through times when future financial uncertainty increased – and this has usually been a time when the economy turned very weak.
In the past year, consumers’ expectations for their future finances have fallen by 15% which makes it one of the steeper falls that we have seen in the past half-century. It is this sort of finding that leaves policymakers between a rock and a hard place. For the Fed, its policymakers have to ask whether they can afford to keep calm about the rise in inflation because further unanticipated increases here could make consumers even more fearful of deteriorating personal finances and possibly induce a recession.
The alternative is to quicken the pace of tightening but if this sets off a new taper tantrum the rise in bond yields could provoke a significant downturn on its own, particularly given that the housing market seems to have bubble-like properties right now. The Fed’s best hope is that inflation recedes and consumers become more confident about their future finances. The economy could pull ahead nicely if an upturn in confidence here coincides with more optimism over the defeat of coronavirus. But is it wise to bet on such a happy ending at this stage?
“We are not so sure. A far more dangerous, but possibly marginally more likely outcome is that high inflation remains more embedded than the Fed expects and consumer concerns about future finances stay depressed as a result. Worse still, if the Fed finally decides that it has to respond to this with faster and/or bigger rate hikes, the resultant rise in yields could be the difference between about of economic weakness and a new recession”, Mr. Steve Barrow said.
With these sorts of thoughts in the foreground right now, it is little wonder that the market seems to be thinking out loud that the Fed’s best option might be to ease in a slightly more aggressive monetary strategy at this stage, rather than wait given the possible cost in terms of having to go far further on rate hikes in the future. Hence, it seems to be hearing more talk that the Fed might use its December meeting to signal a faster pace of tapering so that it cuts the time until it can lift the fed funds target (assuming it will continue to eschew the option of lifting rates at the same time as tapering). This is possible but Mr. Steve Barrow suspected it more likely that the Fed will be a bit more stubborn at this stage and refuse to change the pace of tapering. This could mean another miscalculation and the cost of such miscalculations at this stage could easily be a new economic recession next year.