Is a US recession on the cards after all?

Despite overwhelming pessimism for US markets going into 2023, the tide seems to be turning, with forecasts now mixed on a potential downturn.

According to Stephen Dover, chief market strategist and head of Franklin Templeton Institute, their economists continued to have a “healthy debate” on the outlook for US inflation, with market consensus suggesting it would run at some 3% for the full year.

They also expected the Fed’s policy rate to rise to at least consensus expectations of around 5%, with the possibility of reaching 5.25%. 

“One could describe 2023’s economic outlook as ‘the most-anticipated recession ever’ with surveys of economic forecasters and market behavior in 2022 providing the evidence,” Dover elaborated.

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“Everyone seems to ‘know’ the United States is going to have a recession, and everyone seems to ‘know’ it will be mild. Whenever ‘everybody’ thinks something, that type of herd mentality makes me nervous because often the herd is misguided.

“I gain some comfort from internal discussion and healthy debate among our economists, whose views on recession vary from the possibility of no recession at all, to a ‘normal’ recession, which typically lasts about 10 months.”

In their economic outlook for 2023, Schroders was of the opinion that a US recession was likely in the second half of the year, noting an expected lag in the transmission of monetary policy into economies.

“A lot of borrowing in the [US] housing market was done at fixed rates for long periods of time, 30-year mortgages are the dominant form. They don’t adjust quickly, so it’s taking a while for that increase in monetary policy to flow through and slow things down,” said Simon Doyle, chief investment officer and head of multi-asset, Schroders Australia. 

“Also, consumers have built up surplus savings through the COVID period as governments handed money to people to try to support the economy, and those savings have been drawn down.”

He added, “We do think, certainly in the case of the US, that you will get a recession. It’ll probably start to show up more significantly in the second half of the year as some of those impacts roll through and that will impact profits.” 

Due to the nature of this recession being driven off of policy response, Schroders predicted a 15% decline in earnings, though it acknowledged mixed reviews to recession expectations. 

A recent Bank of America (BofA) survey of almost 300 global fund managers with a combined $847 billion in assets under management found predictions for a US recession stood at 24%, compared to 77% in November 2022.

Investors were still cynical, BofA noted, but far less than they had been in the previous year amid soaring energy prices and aggressive monetary policy from the US Federal Reserve.

“Investors remain pessimistic in February but to a lesser degree, with all key measures of sentiment improving month-over-month and shift in positioning highlighting stronger risk appetite,” analysts stated. 

“The average percentile rank of next 12-month growth expectations, cash allocation, and equity allocation improved in February 2023 to the highest level in a year.”

Goldman Sachs Research, too, recently lowered its odds of a recession in 2023 from 35% to 25%, citing a strong labour market, and expected a more modest yield curve inversion should the US economy prove resilient.

“We think that the extent of inversion … is unlikely to persist,” Goldman Sachs economists Praveen Korapaty and William Marshal wrote.

“Our expectation is that this moderation will be achieved in part by an upward reassessment of long-run real rates”.