As 2023 passes the halfway mark there's plenty of uncertainty about the state of the US economy, the next moves of the Federal Reserve, the health of the banking system, jobs, and more. But there's one thing that Fidelity's Asset Allocation Research Team feels confident about: Another deep and damaging recession like the one that accompanied the global financial crisis from 2007 to 2009 is not lying around the corner.
Cait Dourney of the Asset Allocation Research Team explains that today's economic landscape is very different from the one that existed 15 years ago and made the so-called Great Recession deep and long. "Consumers, mortgages, big banks, and corporate earnings are all in much better shape than they were then," she says. For now, says Dourney, the US remains in the late phase of the business cycle, when the economy is still growing and stock prices may continue to rise despite volatility.
But while a steep and deep decline in economic growth looks unlikely, an increasing number of factors suggest a less severe recession may arrive as soon as the second half of 2023. One of the most significant is the Federal Reserve's determination to raise interest rates until they bring inflation under control. The Fed left rates alone at its June meeting but also indicated that taming inflation remains its top priority and higher rates remain its primary tool for doing the job. Dourney says that if the Fed resumes raising interest rates, it "poses a risk of slowing down the economy later on in 2023. At this point, the economy is showing resilience because consumers have excess savings and unemployment is historically low. Corporate profits have declined from their peak in 2022 but are still very high relative to history. This resilience has contributed to inflation remaining above the Federal Reserve’s target."
What's a recession and when might the next one arrive?
Throughout history, economies have followed a pattern where activities like buying, selling, investing, and working increase until they decrease for short periods of time. These periods of decreased activity are known as recessions and have historically lasted an average of 9 months before activity begins to increase again. The challenge for economic forecasters, investors, and consumers alike is to determine when the shift from increasing activity to recession may take place.
Naveen Malwal is an institutional portfolio manager with Fidelity's Strategic Advisers. "I'm often asked, ‘Is the recession here?' or ‘Is it coming soon?,'" he says. "The truth is that it's nearly impossible to predict the start or end of a recession."
Watching the curves
One place to look for signs that a recession is approaching is the market for US Treasury bonds. Comparing how much interest bonds that mature at various times are paying is a popular method used by recession-watchers. It is noteworthy whenever yields on bonds that mature in the relatively near future rise higher than those of bonds that mature at a more distant point in time. It's been more than a year and a half since yields on 10-year US Treasury notes fell below yields on 2-year notes.
However, history shows that an inverted yield curve forecasts recession much in the same way that autumn forecasts winter: While one eventually follows the other, nothing indicates when the snow will start falling. Indeed, the length of time between the inversion of the curve and the onset of recession has historically varied from as little as 6 months to as long as 4 years, says Director of Quantitative Market Strategy Denise Chisholm.
Dourney agrees that an inverted yield curve is typically a reliable indicator of a future economic slowdown or recession, having inverted prior to the last 8 recessions. The team especially looks to the 10-year to 3-month yield curve, which has historically inverted on average a year before the start of a recession. The curve inverted last fall, signaling rising risk of recession in late 2023. However, historically, recession has followed the curve's inversion by anywhere between 4 and 21 months.
While the curve is sending vague messages, other data is giving signals that the US economy is heading toward a slowdown. Familiar indicators such as gross domestic product and unemployment remain positive but are not reliable predictors of an approaching recession because they show what has happened, rather than suggesting what will happen next.
Instead, the Asset Allocation Research Team bases their expectations that a recession is approaching on indicators that track corporate profits, inventories, and credit. Other indicators that measure consumer spending, housing, and manufacturing activity also suggest that a slowdown may be approaching.
The US economy is slowing, but still growing
The US gross domestic product (GDP) has continued to grow so far in 2023 but has now declined for 3 consecutive quarters. Seventy percent of this economic activity is the result of consumer spending. No matter how gloomy consumers may be about the economy, they are continuing to fuel the expansion by spending their money. Monthly personal consumption expenditures declined after the beginning of the year but has since leveled off. Worried consumers could push the economy toward recession if they respond to anxiety about a recession by cutting their spending.
One less worry
One factor that suggests that any downturn could be mild is the recent moderation of energy prices. When the war between Ukraine and Russia began, high oil prices raised anxiety, putting noticeable pressure on many people’s budgets and raising questions about whether 1970s-style stagflation could return.
But over the past year, energy prices have come down and the chance of a 1970s-style oil shock now appears minimal. Indeed, Chisholm says that oil prices would need to rise to between $150 and $160 per barrel on a sustained basis to create the type of a shock that historically has been capable of tipping the economy into recession.
How should you invest now?
The evidence that a severe recession is not imminent is strong, but investors—like consumers—may remain anxious. But while stocks have historically fallen during recessions, they have returned almost 10% in the year after the yield curve inverted, says Chisholm.
"What we know from history is that recessions come and go," says Malwal. "But stocks have historically risen over time. That's why I believe it's important that investors not react too strongly to predictions of what's going to come. In this kind of environment, I believe it's important to stay invested. Historically, when investors get out of the market because of fear of a downturn, it's rare for them to get back in at the right time, and this often leads to them missing out when things start to improve, which has historically often happened before a recession ends."