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So when is the recession coming?

Key points at a glance

  • Consumption in 2022 held up incredibly well.
  • It was boosted by excess savings from the time of the COVID-19 pandemic and a strong labour market. However, both factors are starting to falter.
  • Despite everything, the only scenario the equity market seems to be considering is mild recession.

Consumer spending, especially in the U.S., is the backbone of the economy. One look at U.S. GDP will confirm this: at 70%, it accounts for the lion’s share of economic output. The state of consumer spending, therefore, gives a good insight into the state of health of a nation’s economy. In view of the double whammy of higher prices – for instance, for food and gas – and higher interest rates – such as on mortgages – consumer stress has been higher in 2022 than in decades. Despite these annoyances, consumer spending held up incredibly well last year.

U.S. GDP did fall in the first and second quarter, which, according to the rule of thumb, qualified as recession, but the U.S. was not officially in recession. This caused a degree of confusion, as was evident from the number of Google searches for the term “recession”, which shot up at the end of July after the release of the initial estimate for second-quarter GDP. A rule of thumb is therefore not enough; what is needed is a fine sense of understanding. The National Bureau of Economic Research (NBER) has the final say on whether or not the U.S. is in recession. The NBER states that the breakdown of GDP (as well as other factors, such as the labour market) plays a role. In fact, the negative growth in the first quarter was as a result of a trade deficit and the negative growth in the second quarter was mainly attributable to the decline in inventories. However, consumer spending continued to increase strongly throughout the year.

One would have thought otherwise from the adverse environment in 2022. One reason for the strong consumer spending was the excess savings that had been accumulated during the COVID-19 crisis acting as a buffer. The combination of state transfer payments and less spending during the lockdowns greatly increased the size of U.S. citizens’ savings. The U.S. central bank, the Fed, estimates that an extra USD 2.3 trillion was saved in 2020 and 2021. Another reason is that the strong labour market boosted growth in consumption. At the end of the year, the unemployment rate of 3.7% was close to the historical low in past decades. The vast majority of the labour force is therefore in employment.

It is difficult to imagine a recession without weak consumer spending.”

Philip Bold

However, both factors are starting to falter. The excess savings from the time of the pandemic have been dwindling since the third quarter of 2021. These diminishing extra savings and the economic uncertainty are affecting consumer sentiment. According to a consumer survey conducted by the University of Michigan, willingness to purchase durable household items has recently fallen to historical lows. The same goes for the purchase of other discretionary goods. However, there are also signs of problems with buying everyday items. In the latest household survey by the U.S. Census Bureau, around 40% of respondents said they were finding it difficult to cover ordinary household expenses. The pressure on the low income brackets – those who are living from hand to mouth, so to speak, and who are particularly hard hit by falling real wages – is becoming apparent. At the same time, the labour market is on the turn. Although anecdotes about recruitment freezes and layoffs are coming mainly out of the technology sector, they are happening across the board. Leading labour market indicators – such as initial claims for unemployment benefit – confirm this trend. This will put additional pressure on consumption.

The positive contribution that consumer spending made to GDP in 2022 therefore seems to be touch and go for 2023. And once the labour market turns there will be nothing standing in the way of recession. Or will there? The inversion of the yield curve at any rate shows that bond market participants consider an economic downturn likely. The equity market, on the other hand, lost a lot of ground in 2022, as a result of which valuations have more or less returned to normal; however, an earnings recession on the corporate front would take a greater toll. Although everybody is talking about recession, the equity market, which anticipates real economic development, only seems to be considering a relatively mild recession. Where to for consumer spending?

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