There could be, given today's current climate, says this chief economist
There is a real risk of recession in the next 18 months, given the current global and economic situation with all its challenges, says one chief economist.
“Much of the recession debate thus far has centered around how often central bank tightening cycles have culminated in recession, or the extent to which commodity shocks result in recession,” said Eric Lascelles, RBC Global Asset Management’s chief economist. “These are useful analyses and suggest that the risk of recession is high over the next 18 months.
“There is another, inflation-centric, way of highlighting this elevated risk of recession. Put simply, every time inflation has risen this sharply, a recession has resulted.”
He noted there have been three major inflation leaps during the late 1960s to early 1980s. While inflation is partly responsible for the subsequent recessions, he said that central bank tightening also occurred in most of the episodes. But, inflation fell sharply after that, dropping three to 12 percentage points in each episodes.
While he noted that the risk of recession is now “quite elevated”, if one occurred, it would likely help to crack inflation, which remains extremely high. While the monthly rate of inflation change is expected to decelerate, it’s still exceeding expectations.
“That’s the most important target for the economy over the next few years, far outweighing any brief interlude of economic decline,” he said.
Lascelles noted the financial markets have already given considerable thought to the possibility of recession. The stock market has declined in anticipation of less favourable economic conditions ahead. While he thought a further decline was possible, he said the markets might “celebrate the taming of inflation, even if it comes with economic costs”. Or, they might prove as forward-looking during this coming episode as they did during the initial pandemic phase.
“At that time,” he said, “a colossal economic decline was tolerated, given the prospect of a full recovery later.”
Lascelles noted that financial markets are continuing to struggle, with the U.S. 10-year yield now up to 3.1% and the S&P 500 index down 15% from the start of the year. The market’s concerns revolve primarily around soaring inflation and whether that might become a structural problem, but they’re also concerned about brisk monetary tightening, the ongoing commodity shock, and China’s economic slowdown as well as the recession risk.
So far, he said, consumers are acting like high inflation is temporary. They seem to think it’s a bad time to buy things, given that their costs have risen substantially.
“In principle, this is a good attitude to have,” he said. “To the extent that expectations help to determine inflation outcomes, it reduces the risk that inflation will become structural.”
But, it also means they could reduce their consumer spending. So, some companies, expecting weaker consumers, are already reducing their production. But discount retailers and brands are noting that consumers are becoming more cost-conscious. He said some consumer spending caution could be good to reduce supply chain pressures and tame high inflation.
Lascelles said that the labour market is tighter than it’s ever been, and also tighter than it looks, especially since many people have retired early or left the labour force. Wage growth is unprecedentedly strong, especially among fast-food and part-time workers, who have nearly caught up to the wage growth of full-time workers. It’s also a generationally tight labour market.
The economy is overheating, which also contributes to high inflation. He said it will take more than easing supply chains to reduce inflation: an economic deceleration is also necessary.
While Lascelles noted that one business cycle scorecard still concludes this is ‘mid-cycle’, it “continues to rush forward at an unusually fast clip”, so it could also be ‘late cycle’ or beyond. He expects this business cycle to be shorter than others, perhaps five rather than ten years.
“But, with the distinct possibility that the cycle could look ‘late’ within the next quarter or two, and given elevated recession risks,” he said, “it could be that this cycle only ends up lasting three or four years instead.”
