Is the U.S. recession looming on the horizon?

In March, when Silicon Valley Bank declared bankruptcy, Dhaval Joshi, BCA Research's chief strategist, predicted that an economic recession was more imminent than anticipated.

Despite initial appearances to the contrary, Joshi's forecast has continued to loom large in recent months.

The U.S. economy has remained strong with subdued inflation and unemployment maintaining lows last seen in the 1960s - with GDP growth for Q1 being revised upward - nevertheless, concerns about an impending recession persist.

The S&P 500 index is a bellwether for the U.S. economy and provides insights into the health of the market by tracking stock movements of the top-performing companies. So far this year, the S&P has shown strong performance, with a 15.03% increase year to date. Despite this, it remains about 8% below its all-time high of 4796.56 on Jan. 3, 2022.

The S&P's impressive rally owes mostly to the success of tech companies leveraging AI, with the top ten stocks contributing31.7% of the total market cap. However, these tech giants are generating mismatched earnings, which have decreased to21.5%. Additionally, the transportation, consumer discretionary, and finance industries are down year to date, signaling potential recessionary headwinds.

A reliable recession indicator for the U.S. economy is the spread between three-month and 10-year bond yields. This yield curve has accurately predicted nearly every recession since 1950, with an inversion occurring in 2022 and further widening this year, indicating a recessionary warning.

Under normal market conditions, longer-term bonds typically have higher interest rates than shorter-term bonds. However, when short-term bonds boast higher interest rates than long-term bonds, this is called a yield curve inversion. The Federal Reserve warns that based on the yield curve alone, there is approximately a 70% probability of a U.S. economic recession within the next 12 months.

The resilience of the US economy throughout 2022 and early 2023 can be attributed to two main factors: elevated post-pandemic consumer savings and a strong labor market.

The COVID-19 pandemic prompted significant fiscal stimulus that resulted in record-high savings rates not seen since World War II. These savings have cushioned consumers against the effects of inflation, tight monetary policy, and weakening economic conditions in recent years.

As 2022 drew to a close, the savings rate began to decline, hitting historic lows amid a challenging macroeconomic environment. Consumers were forced to dip into their savings, resulting in a steady drop from the post-pandemic peak of over $2tn in July 2021. As it stands, current savings rates are at $0.5tn and are projected to be fullydepletedby September 2023.

Consumer confidence is another important indicator of economic health. When people are confident about the economy, they tend to spend more money, boosting the economy's performance. Conversely, if confidence levels fall, people save more and spend less, leading to economic slowdown.
Recent data indicates that consumer confidence has been declining in recent months due to concerns over job security and potential recessionary headwinds. However, consumer confidence improved in June, reaching its highest level since January 2022. Despite this positive trend, the expectations gauge continues to signal a warning for investors, suggesting a possible recession within the next six to twelve-month period.
These fluctuations in consumer confidence demonstrate the impact of wider economic trends on individual spending habits and highlight the continued uncertainty facing the U.S. economy.

The manufacturing sector is a critical bellwether for the U.S. economy, and recent signs of a slowdown have caused alarm among market experts. Manufacturing activity is often sensitive to changes in demand and is measured through the Institute for Supply Management's (ISM) Manufacturing Index.

A decline in manufacturing activity can signal decreased demand for goods, potentially leading to broader economic contraction. Unfortunately, the ISM Manufacturing Purchasing Managers Index (PMI) fell to 46.0 in June 2023, its lowest level since May 2020. In the past 11 recessions, the index had ranged from 42.1 to 66.2 in the month before a recession began, with an average rating of 49.7.

However, in the past eight months, the U.S. economy has been below this average, indicating significant challenges ahead. The current PMI level of 46.0 is concerning as it is lower than nine of the last 12 recessions, raising concerns about the potential for negative economic impact.

Since the late 1960s US yield-curve inversions have predicted all eight US recessions, beginningroughly a yearin advance. The yield curve’s forecasting record since 1968 has been perfect: Not only has each inversion been followed by a recession, but no recession has occurred in the absence of a prior yield curve inversion.

Given the current market conditions, it is unlikely that the Fed will make significant cuts to its policy rate over the remaining months of 2023. This trend could result in a more severe US recession, with the potential for it to extend to 2025.

Nathan Thooft, co-head of global asset allocation at Manulife Asset Management stated that while economies have had a better start to 2023 than anticipated and technically avoided a recession, they only managed to postpone rather than completely avert an impending recession. The tightening of credit conditions and slower lending growth suggest the risks inherent in the broader economic outlook.
Thooft's assessment, consistent with other experts' forecasts, is expected to continue in the near term, with global growth settling below the 3% threshold that would signal a full-fledged global recession if breached.