To The Moon

Economists are falling over each other to correctly predict the next recession. Whenever the recession comes, it will undoubtedly be the most predicted recession ever. Yet past experience shows that predicting a recession is almost impossible to do, just as there is no good model yet to predict inflation. To predict a recession, there are several indicators. Popular is the use of the yield curve. The moment short-term interest rates are higher than long-term interest rates, the curve is inverted, an indicator of a recession. In fact, the market is being asked whether interest rate hikes are having an effect, and the moment the curve is inverted, the market is confident that inflation no longer needs to be a problem. Besides the 10-year minus 2-year, there is also the 10-year minus 3-month and the latter is just a little better at predicting a recession. But the start of a recession does not coincide with the inversion of the yield curve. There may well be some time in between. Even then, there is no 100 percent score.

Furthermore, in a typical recession, the economy falls off a cliff, so to speak. This usually involves a problem that creates systemic risks, such as the collapse of Lehman or the September 11 attacks. Perhaps financial markets are still able to predict those two phenomena, but the last time the curve was inverted (in 2019) does not seem to have any relation to the coronavirus, a virus that did cause a short and deep recession in 2020. So, as certain as the predictive value of the yield curve seems, it is better to look further at just the predictive value of the market itself. The market can predict 10 out of seven recessions well, but it is also wrong sometimes. By the way, this is even more true for inflation expectations based on inflation-linked loans. Central bankers hang all kinds of things on them these days, but these inflation expectations were apparently unable to predict the current high inflation in recent years. There is no relationship between inflation expectations and inflation, especially when there are so many disruptive developments running through them, such as central bankers buying these loans in abundance or when such loans are exclusively part of pension portfolios (in the UK).

A recession is often caused by a central bank, namely by the bank continuing to raise interest rates for too long. That seems to be the case this time too. The cause is that central bankers initially misjudged rising inflation. From the outset, inflation was given the stamp of 'transitory', transient and because inflation was a temporary phenomenon, central bankers did not need to take action. This was the basis for the strong performance of growth stocks in particular in the year 2021. Indeed, there is a strong correlation between the level of real interest rates and the relative performance of growth stocks. Especially around zero, interest rate movements have exponential effects on relative valuation and can go hard. In 2021, inflation rose but not interest rates, and, as a result, real interest rates were extremely negative, almost a prerequisite for a bubble. Because central bankers got it wrong then, they cannot afford a second mistake now. After all, confidence in central bankers is at stake. Suddenly, there is an admiration for Volcker and his policies. Moreover, central bankers have abandoned all inflation models. There is only hindsight, while it is clear that inflation will soon come off in the coming months. This overkill is causing systemic risks to increase rapidly, something central bankers now recognise in both the US and Europe. Moreover, the moment a 'too big to fail' institution threatens to collapse (such as the UK pension funds), central bankers can move quickly.

Another indicator of a recession is the Leading Economic Indicators (LEI). In fact, these are 10 indicators summarised in one indicator, including, for example, the state of the stock market, orders, building permits and also the state of the yield curve.

That LEI has been falling for eight months in a row now, but again, a falling LEI does not necessarily lead to an immediate recession. Moreover, the LEI usually bottoms out at the end of the recession, making this indicator less forward-looking anyway, than its name would suggest.

Finally, for central bankers, the labour market is an important part of decision-making. Ultimately, higher prices are not a problem as long as this does not cause workers to demand higher wages. Higher disposable income means more purchasing power, a gap that is quickly filled by further rising inflation. That labour market looks overstretched, but there are some phenomena underlying it, and these too are partly caused by monetary policy. Post-corona, not everyone appears to be reporting back to the labour market. Now that in itself is difficult to determine because the Gig economy (self-employed workers) has grown significantly in recent years. Research during the corona crisis shows that as many as 1 in 3 Europeans considered quitting their jobs and going self-employed. Furthermore, numerous nonsense jobs were created due to low-interest rates. Companies were created that benefited from the free money but could not (or not all) be profitable. Suddenly we were surrounded by uber-drivers, numerous delivery services, health coaches, personal trainers, etc. Furthermore, crypto and NFTs allowed large groups to (re)earn money, and increased prosperity thanks to a generous government (which nowadays wants to solve every citizen's financial problem with even more money) meant that more and more working people had to work less or could even retire earlier. On top of this, it is precisely the baby boomers who are now retiring, a relatively large group of form who stop working and start consuming only thanks to a filled pension pot. An average terrace in the province is soon full of these over-65s to marvel at the lack of decent service there. Of course, it is not easy to predict what all these people will do, but some of the crap companies will fall over and worse economic times (due to high inflation) will cause more people to work. When all economic indicators are lined up, a recession in Europe seems to have already begun, although it is mainly caused by part of the economy being locked by high energy prices. The ECB's interest rate hikes ensure that this part of the economy also has little recovery potential left, achieving exactly the opposite of what we envisaged with the robust chains. A recession in the United States is less likely in the short term. If it comes, not be until the second half of 2023. We may even have to wait until 2024. In the meantime, thanks to rapidly falling inflation, it is possible that the Fed will adjust policy and so there is even a small chance of a soft landing for the economy. In the somewhat longer term, however, this does mean that higher inflation will stay with us a bit longer, but that is only a concern after this recession.