The resiliency of the U.S. economy in the face of rapid monetary policy tightening has been one of the big surprises of 2023. Entering the year, most economists were forecasting a recession. Economic activity continued to grow at a solid pace during the first six months and is believed to have accelerated during the third quarter. According to the Atlanta Fed’s widely followed ‘GDPNow’ model, GDP is expected to have grown at 5.4% from the prior year.

We shouldn’t be surprised that so many economists got the recession call wrong. As the famous quote often attributed to Yogi Berra goes, “It's tough to make predictions, especially about the future.” For something as large and complex as the economy, the difficulty level goes from tough to impossible.

A recent study published by the Federal Reserve Bank of St. Louis highlights the futility in making these predictions. It evaluated recession forecasts made by the Survey of Professional Forecasters (SPF) ranging from zero-quarters away out to four-quarters away. A zero-quarter away prediction is often referred to as a ‘nowcast’ and reflects the current quarter. The GDPNow model previously referenced falls into this bucket.

The chart below illustrates the R² of the SPF predictions for each period, which can be interpreted as how much of the variation of the outcome (did a recession occur?) is explained by the recession forecast. The results do not inspire confidence. The R² of 38% for the zero quarters ahead period suggests the predictions explained less than half of the actual outcome. As the SPF attempted to predict future quarters, their predictions rapidly lost explanatory power. By just four quarters into the future, their predictions carried virtually zero explanatory power. As it turns out, Yogi was on to something.

The effects of monetary policy do not ripple through the economy immediately. Instead, there is said to be a ‘long and variable lag’ between a shift in policy and when the impact is felt. It appears the lag may be longer than usual in the current tightening cycle.

High government spending and historically low interest rates on fixed-rate loans allowed individuals and businesses to shore up their balance sheets coming out of the pandemic. This buffer has thus far cushioned the impact of higher interest rates. Ultimately, this may be what tripped up those who believed a recession would arrive this year. Recent data, however, indicates consumer savings are in decline while debt is increasing to support consumer spending. As a result, the buffer may be evaporating.

It’s impossible to know if the high growth that people are expecting for Q3 will come to fruition or if that growth can be sustained into the future. As the chart above illustrates, the ability of professionals to forecast what is happening, even in real-time, is weak at best. In such an unpredictable world, diversification remains one of the best tools for dealing with uncertainty.

Majerovitz, Jeremy. “Can Economists Predict Recessions?” On The Economy Blog. Federal Reserve Bank of St. Louis, September 26, 2023

Week in Review

• A recent report from the Commerce Department showed a much higher-than-expected increase in September Retail Sales vs. the prior month. The report is among those being watched by the Fed as it debates the future path of monetary policy. Treasury yields jumped following the data release, and the Fed fund futures market began pricing in a higher probability for another rate hike beginning at the December meeting.
• According to FactSet, 6% of the S&P 500 has reported Q3 results as of last Friday (10/17). The earnings growth rate, blended between companies that have already reported with the estimates for those that have yet to report, is at 0.4% year-over-year. Expectations for the earnings growth rate at the onset of earnings season was -0.3% year-over-year. If the blended-rate estimate comes to fruition, it will be the first quarter of positive year-over-year earnings growth for the S&P 500 since Q3 of 2022.
• Last week, the Consumer Price Index (CPI) headlined the economic data releases. Year-over-year inflation increased slightly more than expected during the period, rising to 3.7% versus the 3.6% estimate. Core CPI, which strips out the volatile food and energy components, declined to 4.1% year-over-year.

Hot Reads

Markets

• Retail Sales Rose 0.7% in September, Much Stronger Than Estimate (CNBC)
• Top Economists Unanimous On “Higher for Longer” Rates As Inflation Threats Linger (CNBC)
• Homes Sales On Track For Slowest Year Since Housing Bust (WSJ)

Investing

• A Reminder of What’s Important (Michael Batnick)
• A Few Laws of Getting Rich (Morgan Housel)
• The Worst Bond Bear Market In History (Ben Carlson)             

Other

• Getting Into This Fitness Trend Is Simple. Just Pack a Bag (WSJ)
• Rickie Fowler, Max Homa to Star in Netflix’s First Live Golf match (Golf Digest)
• None of Your Photos Are Real (Wired)

Markets at a Glance

Source: Morningstar Direct.

Source: Morningstar Direct.

Source: Treasury.gov

Source: Treasury.gov

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

Economic Calendar

Source: MarketWatch

IMPORTANT DISCLOSURE INFORMATION