From Kelton To Krugman To Dalio: A Recession Diary

Humans harbor a perverse fascination with calamity.

I revisit this topic from time to time. We like movies about the apocalypse, we can’t resist sensationalized coverage of tragedies and we’d sooner stare at a car accident than help the people involved.

In markets and economics, our affinity for the macabre finds expression in breathless media coverage of stock selloffs and incessant speculation about the proximity of the next recession. The deeper the market malaise and the higher the perceived odds of a downturn, the more hyperbolic the coverage.

This isn’t always an innocent phenomenon. Fear has become the new cognitive principle. And fear is self-reinforcing. If you spread fear, it looks like you have a deep knowledge of things. If you’re calm, it’s like being ignorant.

As JPMorgan’s Nikolaos Panigirtzoglou noted last week, “heightened concerns about the prospect of a US recession,” as manifested in web searches and market pricing, can “become self-fulfilling” if they persist. Robert Shiller recently said the same thing.

The figure (above) shows the prevalence of the word “recession” in news stories on a weekly basis going back one year.

Currently, America is obsessed with recession risk and while obsession is never healthy, there are plenty of good reasons to be concerned. Unlike Q4 2018, when market participants scared themselves into a short-lived bear market, there’s a clear and present danger of a downturn in the world’s largest economy. That does warrant discussion and, to the extent an informed citizenry is a prepared citizenry, I suppose blanket coverage could be helpful.

The problem is that unlike March of 2020, a recession isn’t, strictly speaking, inevitable. Joe Biden and Janet Yellen are correct in that regard if by “inevitable” they mean a mathematical certainty. I’ve suggested a downturn is basically inevitable, but it’s not the same kind of foregone conclusion as it was when we shut down the entire economy and locked everyone in their homes two years ago. Given that, there’s a non-negligible risk that consumers who were already inclined to pull back on spending in the face of generationally high inflation will retrench further after being inundated with a tidal wave of recession news coverage. Businesses could fall victim to the same psychological trap.

So pervasive is the recession story that it’s virtually impossible to keep track of who said what and when on a daily basis. Literally everyone is talking about it. At the risk of perpetuating the very same self-fulfilling dynamic mentioned above, I thought it might be useful or, at the least, entertaining, to present a compendium of recent recession and bear market banter from notable economists, analysts and executives.

As you read, remember: The only thing we have to fear is fear itself.

A recession is inevitable at some point. As to whether there’s a recession in the near-term, that’s more likely than not. It’s not a certainty, but it appears more likely than not. — Elon Musk, June 21, 2022

We’re not yet in a recession, but we’re getting very close to it. My baseline is a hard landing. If you’re looking at consumer confidence, retail sales, manufacturing activity, housing — they’re all slowing down very sharply. That’s stagflation. It’s not just a recession. — Nouriel Roubini, June 21, 2022

We need five years of unemployment above 5% to contain inflation — in other words, we need two years of 7.5% unemployment or five years of 6% unemployment or one year of 10% unemployment. These are numbers that are remarkably discouraging relative to the Fed view. Is our central bank prepared to do what’s necessary to stabilize inflation if something like what I’ve estimated is necessary? — Larry Summers, June 20, 2022

I thought everyone in the biz knew this, but part of the problem is that “wage-price spiral” is a really bad term for what we’re really worried about. The real concern is self-fulfilling inflation — inflation not driven by demand exceeding supply, but simply everyone raising wages and prices because they expect others to be raising wages and prices. The point is that it matters a lot whether we’re just overheated, needing a cooling off of demand and a modest rise in unemployment, or we need years of punishment until morale improves — sorry, “until expected inflation comes down.” The evidence so far doesn’t point to the latter story, although it sure sounded as if that was what Larry Summers was saying. But I understand that the Fed wants to make sure that we don’t get to that point. — Paul Krugman, June 21, 2022

“We have to dial unemployment up in order to dial inflation down” is some fallacious voodoo. Ask yourself who falls into the “we” category and who falls into the “unemployment” category, and you’ll know everything you need to know about the voodoo. — Stephanie Kelton, June 20, 2022

We now see recession risk as higher and more front-loaded. The main reasons are that our baseline growth path is now lower and that we are increasingly concerned that the Fed will feel compelled to respond forcefully to high headline inflation and consumer inflation expectations if energy prices rise further, even if activity slows sharply. The war and further commodity price shocks have admittedly made the echoes of the 1960s and 1970s ring louder. But we are skeptical that hot wage growth and high inflation expectations are as entrenched today as back then. — Jan Hatzius, David Mericle, Ronnie Walker (Goldman), June 20, 2022

I now hear it commonly said that inflation is the big problem so the Fed needs to tighten to fight inflation, which will make things good again once it gets inflation under control. I believe this is both naïve and inconsistent with how the economic machine works. While tightening reduces inflation because it results in people spending less, it doesn’t make things better because it takes buying power away. It just shifts some of the squeezing of people via inflation to squeezing them via giving them less buying power. The only way to raise living standards over the long- term is to raise productivity and central banks don’t do that. — Ray Dalio, June 21, 2022

For us, the end game remains the same. We see a pretty poor risk reward over the next 3-6 months with recession risk rising in the face of very stubborn inflation readings. Equity valuations are closer to fair at this point but hardly a bargain if earnings are likely to come down and/or a recession is coming. We recognize a lot of pain has already been inflicted during this bear market. Nevertheless, we can’t yet get bullish for more than just a bear market trade until we reach the 200-week moving average of 3,500. Even then, we would only expect an oversold bounce until recession risk falls materially. — Mike Wilson (Morgan Stanley), June 21, 2022

Calls to be on recession watch abound. Between an aggressive global central banking community and headline inflation showing no signs of abating, it follows intuitively that investors are increasingly cautious that the Fed’s actions will ultimately lead to a contraction of real growth. The bulk of the narrative is focused on higher borrowing costs undermining hiring and rate hikes having their intended effect. There just appears to be a collective abandonment of the ‘soft-landing’ scenario — but was that ever really on the table? Moreover, while the prospects for a slowdown are being framed as an early-2023 risk, we’re reminded that with second quarter’s GDP tracking at 0.0% in the wake of Q1’s -1.5% print, the higher headline inflation is in June, the more material the prospects for a technical recession in 2022 become. Alas, this wouldn’t be the type of slowdown monetary policymakers would respond to; however, investors might be more inclined to trade it as such. — Ian Lyngen and Ben Jeffery (BMO Capital Markets), June 21, 2022

The Fed seems to be worried more about its legacy than the economy: It is ignoring deflationary and dangerous signals. Relying on lagging inflation indicators like the CPI, Fed Governor Waller is calling for another hike of 0.75% in July. In our view, the US fell into recession during the first quarter. If massive inventories bloat real GDP in the second quarter, they will unwind and hurt growth for the rest of the year. Alarmingly, in early June consumer sentiment fell to a record low extending back to the 1940s. As measured by the University of Michigan, consumer sentiment is lower today than levels reached during the Global Financial Crisis in 2008-09 and the two recessions in 1980-82 when Fed Chairman Volcker was choking 15%+ inflation with 20% interest rates. Volcker doubled the Fed funds from 10% to 20% in less than a year. Powell’s Fed has increased the funds rate 7-fold in the last year and is pointing to another double from here. Its moves already are more draconian than Volcker’s. If inventories and stock prices are leading indicators for employment and wages, which in this case I believe they are, then fears of cost-push inflation a la 1970’s should disappear during the next six months. — Cathie Wood, June 19, 2022

Clearly from her tweet, Wood does not get the punchline of real Fed funds still being highly negative regardless of how much it has risen from very, very small levels in percentage terms. We are very, very far from Volcker territory. We are nonetheless heading for more crashes, bangs and wallops because of how much more financialized the US economy is now than under Tall Paul. — Michael Every (Rabobank), June 21, 2022

I was talking to Larry Summers this morning, and there’s nothing inevitable about a recession. — Joe Biden, June 20, 2022