Is the Recession Postponed or Canceled?

For more than a year now, economists have been waiting for a recession to happen. We speak with Jon Maier, Chief Investment Officer at Global X ETFs, about whether we can still expect a recession to happen and what the latest data is telling us about the state of the economy.

The recession seems to keep getting postponed. Why has it not materialized yet?

Primarily due to the resilience of American consumers, the economy has weathered the Federal Reserve's interest rate increases quite well. The robust labor market has, in part, bolstered consumer confidence, leading to sustained spending. Low and locked in mortgage rates and high housing prices have made owners feel more confident about spending, in the U.S. at least.  Furthermore, advancements in artificial intelligence and corporate investments in efficiency have extended the capital expenditure cycle, providing the market with additional momentum.

Can it still happen?

A downturn in the economy is a possible scenario for sure. The full effects of the Fed’s 525 basis points in rate hikes have not yet fully materialized, and the long-term impact of the increases and higher rates on the overall economy is still uncertain. And while the market may believe that the Fed's cycle of rate hikes is nearing its end, Chairman Jerome Powell has not removed the possibility of future increases, which if they occur, would adversely impact growth.

Another concern is that growth outside the United States, particularly in China, is not strong as expected. Also, the instability in China's property market and the slowing of economic growth could affect global demand. Although at this point most pundits expect a soft landing, a recession is still possible, depending on the severity of the emerging cracks in the labor market and potentially among consumers, but the timeline has moved out some.

What is the latest data telling us about the state of the economy?

The macroeconomic data is conflicting and confusing, making forecasting a challenging task. Recent data from the labor market indicates that the cracks that started to appear earlier this year are reemerging, although the fundamentals remain relatively strong compared to the pre-pandemic period.

The August Consumer Price Index (CPI) report provides a vivid reflection of the dynamic economic challenges that the U.S. faces. Consumer spending has exhibited some signs of weakening as the demand for goods has decreased, albeit from elevated levels. Inflation has seen a significant decrease, both in terms of the CPI and the Personal Consumption Expenditures (PCE), from its highest levels, and it is moving in the direction desired by the Federal Reserve, although not as swiftly as they would like.

Delving into the specifics, core CPI, which strips out volatile food and energy prices, rose by 0.3% month-over-month, slightly higher than July's 0.2% rise. The slight increase in core CPI suggests that we might not be in the clear. And if these numbers continue to grow, the Fed might reconsider its stance on interest rates. In the wake of these figures, one could reasonably anticipate the Fed leaning towards a rate hike, especially if the next report shows a similar or higher trend. While energy prices have contributed to a surge in the headline CPI, the focus should remain on core and supercore CPI.

The latest CPI figures accentuate the delicate balance of our 'goldilocks' economic dynamic. Furthermore, the projections for the United States' Gross Domestic Product (GDP) in the third quarter have risen. With the recent GDP growth reported at a robust 5.6%, the key will be to maintain this growth while keeping inflation in check. On a global scale, inflation in Europe remains high and China's manufacturing numbers have been disappointing. All of this suggests that the market is late cycle, yet with signs that indicate it is possible to avoid a recession, for now.

How are you expecting stocks and the general markets to perform for the rest of the year?

Overall, we are generally cautious about the outlook for markets near-term. The most pressing question remains the sustained resilience of the consumer. While consumer balance sheets are largely strong, auto loans and credit card debt is an area of concern. However, we are less worried about the impact on consumers from the end of forbearance for student loans.

Additionally, downward revisions of non-farm payrolls and weaker July JOLTS reports are concerns that the labor market is beginning to cool off. Despite all of this, the U.S. economy has continued to show resilience throughout this year and there is reason to believe that this resilience can continue.

What will another rate pause from the Fed mean for the markets?  

Markets are pricing in a pause for the September meeting and roughly a 28% chance of an increase at the November meeting. Another pause will likely not impact the market significantly, other than to confirm that we are near the end of the rate-hiking cycle.

However, two things to keep in mind are: first, if there is a shift in Fed policy and they believe another hike is necessary, this could dampen sentiment; and secondly, markets are still pricing in cuts for next year, even though Powell has made it clear that their base case does not call for cuts next year. Therefore, markets may need to reprice this 'higher for longer' scenario, which is something to monitor.

Where are some investment opportunities for investors? Are you watching any specific themes?

Given the complexity of managing higher interest rates alongside slowing growth, diversification becomes increasingly important. We identify some key themes that are poised to benefit from current trends: Notably, ongoing fiscal support and the robust capex cycle are driving performance in specific cyclical market segments, such as infrastructure development. This sector remains resilient to the strengthening of the U.S. dollar, as it is largely a domestic story.

Additionally, surging demand for AI chips underscores the expanding adoption of artificial intelligence helping with the drive for greater efficiency—factors that also reinforce the narrative of the current strong capex cycle.

This interview originally appeared in our TradeTalks newsletter. Sign up here to access exclusive market analysis by a new industry expert each week. We also spotlight must-see TradeTalks videos from the past week.