The widely expected recession hasn’t happened; why not?

05 October 2023

The consensus view has been that we would enter a recession in 2023, but it hasn’t materialised. At our Investment Outlook, Q4 2023 event last week, we sat down with Dermot O’Leary to find out why. Here’s what he had to say. 

The consensus view was that we might see a recession this year, but it hasn’t come to be. Why is that?

Coming into this year, the expectation was – and we said it a year ago – that we thought at that point in time the UK was already in recession; the euro area was going to go into a mild recession in the first half of 2023; and mid-way through the year, we expected the US to follow. The expectation of rolling recessions in the developed world reflected the tightening of financial conditions owing to a very sharp increase in interest rates; and there was a significant bounce back from COVID lockdowns that was going to fade, particularly in relation to the impact on the consumer.

So, why didn’t it happen? It’s because of the US economy. The US economy has been the big outperformer among the major developed economies. Its growth forecast has increased by one percent since the start of the year. We've seen growth of about two percent overall this year, and that actually might go up a little bit higher based on what we've seen more recently.

There are three reasons for this. Let’s start with the consumer: because of COVID lockdowns, excess savings deposits went up to about $2-3 trillion at their peak. But since then, this has gradually been eroded. In other words, US households have been dipping into their savings to maintain their level of spending.

The second reason is US government spending. Fiscal largesse was massive during the pandemic in the US. There was an expectation that this would fade this year and that there would be a negative impulse from the US government. It's actually been a positive impulse which has surprised us.

The third feature, which I think is more longer lasting, is the structural industrial policy in the US. There have been a number of enormous schemes that have been pushed through in relation to the incentivisation of technological change, fab plants, environmental aspects, clean tech, etc. Usually, those things take longer to implement, but there's been a surge in manufacturing construction because of those as well.

So, I think the US economy is probably the main explanatory factor for why we haven’t had a recession.

And are those factors going to fade, or what do you think is going to happen in the coming year?

The risks from a global growth point of view, in our view, now come from China, and, in a European sense, Germany – the latter is related to the former in some degree. 

In the last six months, China’s property market has slowed down significantly. Transactions have plummeted; prices have not. So, that’s having an effect on the economy overall. There doesn't seem to be a real willingness this time by the Chinese authorities to come in quickly and stop the rot. That's not to say that they won't react if things really start impacting the economy overall. But in the short term, that's a risk to global growth given the importance of the Chinese economy.

Germany would be a big manufacturing producer for that particular region. And that’s on top of the problems that Germany is having in terms of energy-intensive industries because of the big change in terms of their energy sources. So, regionally, that’s a concern as we look into the next 12 months.

And those factors I mentioned above around the US in particular; those excess savings look like they’ll run out by the end of the year. So, we won’t have that sort of stimulus coming from the US consumer – and the federal budget deficit will probably go the opposite way as well.

So, I think we're facing into a year certainly of slower growth – and then the lagged impact of interest rates as well.

So, should we now push that recession expectation into next year, or are we talking about a moderation in growth?

I think there's still a risk of recession, but it’s less than we thought. In the US economy, we’re now seeing signs that the labour market is slowing, which is exactly what the Federal Reserve want to happen because they want to reduce wage inflation pressures and thus, reduce core inflation pressures, and then they can take their foot off in terms of monetary tightening.

There are signs that the labour market is slowing and there's more and more talk about a soft landing. Soft landings have never actually happened in history, but we are seeing very unique features of the US economy over the last number of years. Indeed, it looks like that inflation spike was in fact temporary supply-side factors. So, there’s progress on the inflation front, particularly in the US. But I’m a bit more worried about the European picture actually.

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