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The On/Off US Recession

Is the US going into recession? The chances were about 75% at the end of last year that growth would fall below zero for two consecutive quarters in 2023. That fell to about 40% in February as strong jobs data continued. The Federal Reserve responded by increasing interest rates, even in the context of bank failures, in an attempt to slow inflation – down to 5.0% in March from a peak of 9.1% last June.

On 3 May, the Federal Reserve increased interest rates by 0.25% to a 16 year high of 5.0% to 5.25%. While confirming that the Fed’s mission is to manage inflation, Chairman Jerome Powell insisted that the US banking system, source of recent anxiety, is “sound and resilient.” However he admitted that he was unsure of the effects of this, the 10th rate rise in 14 months: “Tighter credit conditions for households and businesses are likely to weigh on economic activity, hiring, and inflation. The extent of these effects remains uncertain.” That statement doesn’t fill one with great confidence. His comments could be interpreted as, we are performing our task as per a narrow definition of that task, but we can’t be sure what the wider implications of our performance will be.

Powell pointed the finger at the government as the source of this uncertainty, specifically the impasse over the debt ceiling, a regular source of noisy debate. The US govt spends about USD 525 Bn a month, of which USD 225 Bn is deficit spending. If Congress does not allow that to expand then the government would have to cut employment, supplier contracts and / or welfare payments. Bond yields for T-bills due for redemption in June rose to their highest since the 2008 crash after Treasury Secretary Janet Yellen said the government might run out of money by then. On 11 May, Yellen called on Congress to raise the federal debt limit to avert an unprecedented default warning that, “a default would threaten the gains that we’ve worked so hard to make over the past few years in our pandemic recovery. And it would spark a global downturn that would set us back much further.”

Tighter credit conditions and lower government spending could combine to push the US into a technical recession. After 1.1.% GDP growth in the first quarter of 2023, there is now anxiety among economists that growth rates will undershoot that level for the rest of this year. Doomsters can easily find scenarios in which a longer standoff between the executive and congress leads to millions of unemployed, collapsing business sentiment, and permanent impairment of the US’s credit rating. It seems unlikely to us that any Congressperson will want to be seen as being in any way implicit in or responsible for such a scenario. The chances are that, following a sufficiently loud period of complaint, the deficit can will be kicked down the road again.

Still, there are credit issues in the US that give cause for concern. In early May JP Morgan Chase & Co bought collapsed lender First Republic Bank and in the following days shares in a number of regional US banks fell sharply as investors looked hard at their banking portfolios, with PacWest squarely in the headlights after a USD 1.1 Bn loss in Q1 and an announcement from its board that it is looking at strategic options.

Higher interest rates and tighter credit conditions could combine to reduce growth to technical recession levels. This after all is the job of the Federal Reserve – to manage inflation using monetary policy, and not to worry about the effects of monetary policy on GDP. The independence of the Fed is a headache for politicians of both major parties, as neither side would like to be in charge of a recession that was not of their making.

The good news is that inflation in the US appears to have peaked already, so interest rates may be near their cyclical peak – barring any US government default – so a monetary recession could be short and not too painful. JP Morgan’s CEO Jamie Dimon has said that he would “take a mild recession happily” over the alternative of a government default trimming several percentage points off GDP growth and potentially causing a run on the dollar.

The bad news is that even a mild recession could be exacerbated by a credit crunch if congress throws sand in the gears of the government. Bank of America credit strategist Oleg Melentyev wrote in a 12 May note that a 15% default rate on corporate debt was a distinct risk, but he sees an 8% corporate default rate in a full blow recession, leading to USD 920 billion of defaults.

Amid all the headline-grabbing prognostications of imminent financial apocalypse, it’s important to remember that none of this has happened yet. All the talk leaves us none the wiser as to whether the US will fall into recession or not this year. So far the world’s largest economy has being doing pretty well in 2023. Our best guess, which we use in our planning, is that the US will avoid a recession but may face a sticky patch of weaker growth. The implication for shipping is largely relevant to energy demand in the US and what that does to oil price and oil exports from the US to e.g. China – and what slower consumption in the US would do to container shipping rates - of which, more later.

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