The Breakdown - So, Are We Headed Into Recession or Not?

Starting point is 00:00:04 Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big-picture power shifts remaking our world. The breakdown is sponsored by nexus.io, near NFTX, and produced and distributed by CoinDesk. What's going on, guys? It is Monday, June 6th, and today we are asking the question, are we headed to recession or not? Before we get into that, however, if you are enjoying the breakdown, please go subscribe, give it a rating, give it a review, or if you want to dig deeper into the conversation, come join us on the Breakers Discord. You can find a link in the show notes or go to bit.ly.com slash breakdown pod. Lastly, a disclosure as always, in addition to them being a sponsor

Starting point is 00:00:50 of the show, I also work with FTX. So today we are discussing the most debated question in economics right now. A few months ago, of course, the discourse was all about inflation. Now it's all about recession. Whether we're headed there, on what time frame, how bad it will be, and what it might mean in terms of Fed policy. Markets are guessing at this, businesses are guessing at this, average citizens are guessing at this. Of course, the Fed is aiming for a soft landing, or as they recently updated their language to a soft-dish landing. What the Fed is trying to do right now is to use rate hikes and quantitative tightening or balance sheet reduction to cool economic activity. The Fed can't fix supply chains. They can't uninvade Ukraine and make energy costs come down.

Starting point is 00:01:38 All the Fed can do is make money lending more expensive, so less of it happens, and hope that pumps the brakes on demand. Now, they're trying to do that in a way that doesn't cause economic harm in the other direction. That soft or soft-dish landing that they're going for is to bring inflation down without causing a recession. But if you've paid any attention at all to the business news over the last week, you've probably noticed a growing chorus of business leaders calling a recession inevitable. So that's the side of the debate we're going to start with, this large and growing group. On Friday, Bloomberg published a piece, Corporate America turns up volume on warnings about economy. So who has weighed in? Peter Hooper is an ex-fed official and now works at Deutsche

Starting point is 00:02:22 Bank as an economist. He was among the first of these commentators to start forecasting a recession and currently puts the odds of one happening next year at 70% plus. Gary Friedman is the CEO of Restoration Hardware. R.H. had an earnings call last Thursday, during which he said, among other things, quote, we've got a long ways to go in raising interest rates to fight inflation. And I think you just have to be prepared for anything right now. Friedman has been on people's radars a bit more after his Q1 earnings call, during which he made what Fortune called, quote, apocalyptic economic predictions. Elon Musk has reportedly told employees that he had a, quote, super bad feeling about the economy while announcing a 10% reduction in staff at Tesla. Commenting on the jobs report

Starting point is 00:03:07 from last week, which we'll get into in more depth than just a minute, Rick Reader, who is the global fixed income CIO at BlackRock said that it was likely to be, quote, the last solid report you're going to get for a long time. Speaking of BlackRock, BlackRock's CEO Larry Fink said he expects inflation to remain elevated for several years. Goldman Sachs President John Waldron said last Thursday, quote, the confluence of the number of shocks to the system to me is unprecedented. PNC Financial Services Group CEO, Bill Demchek, said that the only possible outcome is a recession. Don Patrick, the CEO and CIO of Soros Fund Management, the George Soros Family Office, said,

Starting point is 00:03:44 quote, there's a lot of discussion about a looming recession. And the bottom line is a recession is inevitable. It's a matter of when. I don't think we'll avoid a recession. I just think it will be further out than people expect. It seems as well that these folks are not just individual data points, but also represent a larger growing sensibility. A Bloomberg survey of economists puts the chances of recession in the next 12 months at 30%, which is doubled from 15% in March. Lizanne Saunders, the chief investment

Starting point is 00:04:13 strategist at Charles Schwab, tweeted that the probability of a U.S. recession based on the two-and-ten-year yield curve has risen to the highest since February 2007. Now, you're probably noticing in all of that that the banking and financial services sector seems particularly nervous. We're also seeing a bit of an emphasis on Europe. City Group's CEO, Jane Frazier, said last week that the U.S. is going to have difficulty avoiding a recession, and that it's even more likely in Europe based on high energy costs. These connections to the rest of the world also weighed into maybe the best publicized comments last week, which came from J.P. Morgan, Chief Jamie Diamond.

Starting point is 00:04:47 Diamond has made an about-face from a cautious optimism a few weeks ago to much stronger and more dire language last week. Two weeks ago at an investor conference, he said his economic concerns were, quote, storm clouds that could dissipate. Last Wednesday, however, he followed up and said, you know, I said there's storm clouds, but I'm going to change it. It's a hurricane. We don't know if it's a minor one or Superstorm Sandy. You better brace yourself. J.P. Morgan is bracing ourselves, and we're going to be very conservative with our balance sheet. Right now, it's kind of sunny. Things are doing fine. Everyone thinks the Fed can handle this. That hurricane is right out there, down the road, coming our way. He goes on to discuss quantitative tightening, saying we've never had QT like this,

Starting point is 00:05:28 so you're looking at something you could be writing history books on for 50 years. He went on to say that central banks, quote, don't have a choice because there's too much liquidity in the system. They have to remove some of that liquidity to stop the speculation, reduce home prices, and stuff like that. He pointed to the war in Europe as part of the issue. Wars go bad. They go south with unintended consequences. We're not taking the proper actions to protect Europe from what's going to happen to oil in the short run. And ultimately, he says the bank is following through with specific changes based on all these factors. Quote, with all this capital uncertainty, we're going to have to take actions. Nexo lets you easily buy crypto with your bank card and earn

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Starting point is 00:07:34 When you trade NFTs on FTCS, you pay no gas fees. Download the FTCS app today and use referral code breakdown to support the show. Pretty clear message coming from some of these business leaders, and many in the Twitterati also agree. Alessio Urban, a macro analyst on Twitter, says 2008 Playbook. Economy is strong. don't worry, remain invested in stocks. October 2008, nobody saw it coming. Days before Lemon, quote, the Fed is not currently forecasting a recession. They're fooling, y'all. Collapses underway. Finance Alat says everything the Fed does takes six to 12 months to affect asset prices. It will hit

Starting point is 00:08:13 during the worst part of the recession. This is why acting 12 months late with quantitative tightening and raising 0.5% every month is worse than not acting at all. The warning signs are everywhere telling the Fed to halt. And then, of course, maybe the most definitive source on this, came from Cardi B. When y'all think they're going to announce that we going into a recession? Real Vision's Raul Paul took a little bit more time than Cardi to get into this, writing, so question is whether we're going to get a longer recession where earnings get crushed. A recession due to excess monetary tightening seems pretty clear. We risk a very sharp growth contraction driven by demand destruction. Higher goods prices and higher borrowing costs kill demand.

Starting point is 00:08:50 My base case is 1974, where growth collapsed due to high oil and high rates. 2018 is another decent analogy. Financial conditions were super tight in growth collapsed, leading to the Fed to pivot. 2001 was a different case as earnings got killed too as the recession stuck around for longer. Summary, we have a high risk of a sharp recession that is over and another risk off. It is not a certainty. The odds of a bigger recession are lower but could change. Inflation is a past problem. But you'll have to assess frameworks in real time if equities don't fall further, as that kicks the can down the road and we could see a false hope rally in more Fed. Basically, Raoul is saying that if the Fed sees markets rallying, it may be a signal to them

Starting point is 00:09:30 that they haven't done enough to tamp down the overheating. Now, we're getting sort of wonky here, so it's worth pausing for a moment and recognizing that the technical question of a recession or not maybe isn't the most important part of the discussion. The general definition of a recession is the GDP falling for two consecutive quarters. But relative to people's lives, it's not so much about aggregate economic activity, but a shift to assuming decline in problems instead of growth and opportunity, and real pain showing up meaningfully in day-to-day ways. That makes a recent poll from UGov all the more interesting. Catherine Rampel, a columnist at the Washington Post, tweets, majority of Republicans and plurality of Democrats say they believe we are currently

Starting point is 00:10:11 in, quote, an economic recession. Basically, the poll found that 70% of Republicans, 55% of independence, and 40% of Dems believe that we are currently in an economic recession. and found a very strong correlation between difficulty affording gas and believing that we are in a recession. This is what I mean when I say real pain showing up meaningfully in day-to-day ways. Katie Grefield and Anchor at Bloomberg writes, we're going to speak a recession into existence at this point. Speaking of that sort of pessimism and self-fulfilling prophecy, there's another interesting to mention to this, that Kyla Scanlon, who is a finance content creator, has been covering extensively. Kyla posted a TikTok in which she shared a thought that she thought wasn't all that

Starting point is 00:10:51 controversial, which was saying that we don't need a recession. She got a ton of comments, particularly from young people saying that in fact we did. One representative comment, all well and good if you have a trust fund. If you're an aspirational middle class Gen Z kid like me, I'd be happy with a recession so I can get ahead. The logic here, I guess, is that a recession could somehow bring down asset prices like stocks to a lower level that is more approachable, and even more, I think, that a crash might return houses to something more reasonable. There are a lot of problems with this line of thinking, though, especially on the housing side. It's just not clear that that's what would happen. As we've discussed in previous episodes, much of the problem in housing stems from

Starting point is 00:11:30 the confluence of more than a decade of underbuilding after the global financial crisis, plus secular shifts in how we work and live coming off of the pandemic. Neither of those things changes just because interest rates go up. Now, of course, many would share this sense that hopefully shifts in demand based on the increased cost of financing houses, for example, might bring the overall market down into something more reasonable where buyers can haggle with sellers and don't have a thousand competing offers and things like that. My only point is that it's by no means a sure shot that a recession would actually solve the housing problem in the way that some people might be hoping. Kyla also pointed out that the recession hopefuls don't really seem to be factoring in the

Starting point is 00:12:08 costs that come with recessions in terms of businesses closing, layoffs, etc. But ultimately, this is interesting not for its factual veracity or not, but as a barometer of how this younger cohort is thinking and feeling about things, and it seems pessimistic. So in all of this, is there a side that says, no, we're not headed towards recession, and absolutely there is. Lloyd Blankfine, the former Goldman Sachs CEO, tweeted, dial back a bit the negativity on the economic outlook. If I'm managing a big company, of course, I'm prepping for the worst. But the economy is starting from a strong place, with more jobs than takers, and is adjusting to higher rates. Riskier times, but may yet land softly. Connor Sen says 1.2 million jobs created in the last three months. This isn't anything close to a

Starting point is 00:12:51 recession. Jim Kramer says, I may be the only person besides Jay Powell who believes we are not going to have a recession. At least I hope Jay thinks that way. Now, the running joke with Jim Kramer is basically that you can assume that whatever he thinks the market's going to go the other direction. And so folks like comedian Jimmy Doer wrote, the final sign from the universe was delivered, and it became clear to everyone. There was going to be a recession. But what really are the arguments for the no recession side? Well, you heard the mention of jobs, right? The jobs report was released last week on Friday and non-farm payrolls rose 390,000 last month, which was above the estimates of between 318 and 348,000. The unemployment rate held steady at 3.6%, which is just slightly above the

Starting point is 00:13:31 lowest level since December 1969. Daniel Zhao, whose Glassdoor's senior economist, said, despite the slight cooldown, the tight labor market is clearly sticking around and is shrugging off fears of a downturn. We continue to see signs of a healthy and competitive job market with no signs of stepping on the brakes yet. This is definitely something the Fed's watching. One of the key metrics that Jerome Powell referenced at the May FOMC meeting was that there were more than two job openings for every unemployed American. Basically pointed to that and saying that things are still hot because there are more jobs than people can actually fill, which doesn't seem like an economy on. the decline. A couple of important notes on jobs, though. First, it's that, of course, they're lagging, and last week we started to see big announcements around layoff, so we'll have to keep an eye on

Starting point is 00:14:13 how that changes. And one thing that didn't get a ton of discussion was the fact that small businesses had a much rougher month. They shed 91,000 jobs. The other side of the no-recession stance is actually less about whether there will be a recession or not, but more about how Americans are prepared to weather economic downturn. Joey Politano, who is a Bureau of Labor Statistics employee and economic comment. said, Americans have accumulated $2.5 trillion in excess savings since the start of the pandemic. But that hasn't translated into broad financial security. While slightly more households have a three-month emergency fund, the majority of low-income households still lacks efficient

Starting point is 00:14:47 savings. There is another side to this, which is that credit usage is going up, suggesting that people are having to turn more to credit cards to fund the same level of lifestyle because of inflation, and also in April, the personal savings rate fell to 4.4%, which is the lowest rate since September 2008. Americans have 15% less in non-retirement savings today than they did a year ago on average. Now, this could all just be a reversion to the mean post-pandemic and not be a sign for concern. But where, when you add this all up, does it leave us? Well, the short answer is, of course, no one knows. But what you have to take as signal is the fact that all of these executives are signaling that this is something that they believe is going to come to pass. We have the markets

Starting point is 00:15:28 fully expecting the Fed to raise interest rates again by 50 basis points in each of the June and July meetings, with the question being what happens from September on. The reason that it's worth paying attention to these recession debates is that in the same way as businesses and individual investors are looking to the Fed to try to glean what the Fed is going to do next, and in so doing better understand what they should do next, so too is the Fed going to be watching this conversation around recession, and in particular, what specific moves businesses make to prepare for it as a way to inform what they do from September on. For now, I want to say thanks again to my sponsors, nexus.io, near NFTX.

Starting point is 00:16:07 And thanks to you guys for listening. Until tomorrow, be safe and take care of each other. Peace. Hey, breakdown listeners, come join CoinDesks Consensus 2020, the festival for the decentralized world this June 9th through the 12th in Austin. Texas. This is the only festival showcasing and celebrating all sides of blockchain, crypto ecosystems, Web 3, and the Metaverse, and is designed for crypto newbies, investors, entrepreneurs, developers, and creators. Use code breakdown to get 15% off your

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The Breakdown - So, Are We Headed Into Recession or Not?

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