We keep hearing about a “soft landing.” According to government officials, central bankers, and mainstream financial media pundits, the US economy has dodged a recession.
So why are recession warning signs still flashing?
Most major financial institutions and high-profile economists have abandoned or significantly downgraded their recession projections. Those that still still forecast an economic downturn predict it will be short and shallow.
For instance, during the last FOMC meeting, the Federal Reserve upped its economic forecast, characterizing economic activity as “expanding at a solid pace.” It increased its GDP projection for 2023 to 2.1%, more than double its 1% projection in June. Fed economists do expect growth to slow to 1.5% next year, but any talk of a recession is completely out of the discussion.
But one major financial institution still sees a recession in America’s future - Deutsche Bank.
The German bank was the first major financial institution to project a recession in the US, and it’s sticking to its guns.
Deutsche Bank isn’t just making a calculated guess. It has solid data to back up its projection. The bank’s head of global economics and thematic research Jim Reid and a team of economists recently analyzed 34 US economic downturns dating back to 1854 and identified four macroeconomic “triggers” common to past recessions.
Bad news — all four are flashing red.
In its analysis, the Deutsche Bank team calculated the percentage of times these four events led to a recession. They call this the “hit ratio.” Based on their analysis, they determined that no single trigger can predict a recession. Nevertheless, all four of the triggers most commonly associated with US recessions are in play now.
Reid cautioned that it’s impossible to accurately predict every recession using macro triggers.
But it’s fair to say that the most significant ones [triggers] have been breached this cycle and that the US tends to be more sensitive to these historically.”
The Four Triggers
Following are the four triggers identified by the Deutsche Bank team and their hit rates.
An Inflation Spike (77%) — There’s no question that this trigger is in play. Price inflation soared to a four-decade high in the summer of 2022. While it has cooled in recent months, the CPI began creeping up again in July and continued to rise in August.
Reid said the US economy “seems to have the most sensitivity to inflationary spikes.” Since 1854, a 3% rise in price inflation over a 24-month period caused a recession within three years 77% of the time.
Note that there can be a significant lag in time between the initial inflation shock and the recession.
And while price inflation might be down, it isn’t out. During a recent podcast, Peter Schiff said, “It’s obvious to anybody who opens their eyes that inflation is not topped out and coming down. It’s bottom out and going up. And the people who are blind to this, who are asleep, they are in for a rude awakening.”
An Inverted Yield Curve (74%) —Typically, longer-term bonds offer higher yields than short-term bonds. A 10-year Treasury generally features a lower yield than a 30-year. This is because investors typically factor in more risk on a longer-term loan. When this flips and short-term bonds start yielding more than long-term bonds, it’s called a yield curve inversion.
The US Treasury yield curve has been inverted since July 2022.
Yield curve inversions have preceded a recession 74% of the time since 1854. If you consider a more modern period since 1953, the hit rate increases to 79.9%.
A Rapid Rise in Interest Rates (69%) — To fight price inflation, the Federal Reserve has hiked rates by more than 5% in just 18 months.
Since 1854, a 2.5% increase in short-term interest rates over a 24-month period led to a recession 69% of the time. As Reid put it, interest rate hikes haven’t ended well for the economy. He said, “The US seems to have the most sensitivity to interest rates. The US cycle has historically been more boom and bust than others in the G7.”
That’s likely because the US economy runs on borrowing and spending. It can’t function for very long in a high interest rate environment. Schiff summed it up in another podcast.
The economy is built on a foundation of cheap money. It’s not just the economy; it’s every facet of it. The government, the deficits, the government budget is built on cheap money. And it’s not just the federal government that’s been gorging on this cheap money. A lot of the state governments, municipalities — they’ve all issued a tremendous amount of debt over the last 15 years.”
The last time rates were at this level was in 2006. We know how that ended. But there’s a big difference between then and now. There is even more debt in the economy. Consider that in 2006, the national debt pushed above $10 trillion for the first time. Today, it is more than three times that level.
Oil Price Shock (45%) — The price of Brent crude has spiked by about 33% since June. This has thrown cold water on the “disinflation” narrative.
When oil prices have spiked 25% over a 12-month period, the US economy has gone into a recession 45.9% of the time.
Conclusion
As you can see, all four of these triggers are in play today. This is yet another reason to question the mainstream’s sanguine view of the economy.
As Schiff explained, most people in the mainstream don’t seem to grasp the gravity of the situation. They don’t realize that we are at the beginning of the end of this whole phony economy. He said Fed chair Jerome Powell could put off the implosion in the short run by doing something drastic to change the narrative. That would entail at least hinting at interest rate cuts.
Otherwise, this is going to happen. Whether it’s tomorrow, the next day, or the next week is hard to tell. But what seems apparent to me is that we’re about to go over a cliff. I just don’t know how much more distance there is between where we are now and the edge of that cliff. But we’re going there.”
