Seven Reasons Why No Recession
Authored by Ned Davis
When the Fed started QT and raised rates sharply leading to an inverted yield curve starting in early 2022, Chairman Powell warned of pain to come, which nearly all economists believed would lead to recession.
We did get a slowdown for a while, but no recession, and today I would like to offer some reasons why. I’d like to just say it was because our Recession Probability Model and Recession Watch Report never saw the majority of indicators turn bearish, but it is probably more useful to look at individual positive indicators that may give a better perspective.
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Financial Conditions Positive
The short answer to why no recession might be seen in the chart above. The above chart is an NDR indicator of financial conditions. As can be seen, it did fall into the moderate growth zone as the Fed tightened, but it subsequently rose to the growth mode where the economy has hypothetically risen at a rate of 3.3% per annum real growth.
As to why financial conditions never fell to recession levels, let’s turn to monetary policy. Real monetary growth did reverse after the boom in growth during COVID, but it subsequently rose again before any real damage was done and was aided by more fiscal stimulus in terms of infrastructure spending, as shown in Figures 2 and 3.
Figure 2 – Monetary Growth Has Recovered After Post-Pandemic Correction
Real monetary growth did reverse from the boom in growth after the COVID recession, thanks to QT, but it subsequently rebounded to “strong monetary growth” before any real damage was done.
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Figure 3 – Policy Index Remains Bullish For Stocks
This shift in money growth was aided by more fiscal stimulus in terms of infrastructure spending. I thought we needed to address that, and as can be seen in this chart, we have been in a zone where historically stocks have risen sharply.
However, this key policy tailwind for growth turned down sharply in Q1, confirmed by lower than expected GDP growth, so this is something that we need to keep an eye on.
However, this key policy tailwind for growth turned down sharply in Q1, confirmed by lower than expected GDP growth, so this is something that we need to keep an eye on.
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Debt Service Low and Positive Wealth Effect
With an inverted yield curve and banks tightening lending standards, logic and history would argue that credit conditions would tighten severely. But our NDR measure of credit conditions stayed mostly favorable and debt service remains low, as shown in Figures 4 and 5.
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Figure 4 – Credit Conditions Have Remained Favorable Despite Tightening
Despite an inverted yield curve and banks tightening lending standards, our NDR measure of credit conditions shown here, stayed mostly favorable. Joe Kalish explained to me that much of this was due to shadow lending from outside the banking system.
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Figure 5 – Net Interest Payments Relative To Cash Flow Have Plunged
To explain why the huge rise in interest rates turned out to be not that painful, one needs to go back to the near decade of zero interest rate policy and QE before this cycle.
This allowed most corporate and mortgage debt to be refinanced at very low rates. Those who did that saw no rise in their debt service. In fact, as featured in this chart, net interest payments for non-financial corporations, relative to cash flow, plunged to the lowest level in many decades. This was a huge boost to corporate profits.
Likewise, the effective rate for mortgages has been estimated by others to be around 50% lower than current mortgage rates. The downside to this is that many people feel locked into their low mortgage rates and they feel that they cannot sell, keeping supply off the market and keeping prices rising.
The “wealth effect” from rising stocks and home prices has also been a huge help in keeping us out of recession, as shown on the charts in Figures 6 and 7.
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Figure 6 – Strong Stock Market Performance Positive For The Economy
The very sharp rise in stocks, shown below, has historically been positive for the economy.
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Figure 7 – Home Prices Have Started To Rise Again
Despite a terrible market for new real estate transactions thanks to current mortgage rates, existing home prices have actually risen, as shown in the chart below.
So the “wealth effect” from rising stocks and home prices has also been a huge help in keeping us out of recession.
The factors shown today, I believe describe well the present, but if the Fed keeps rates higher for longer, the painful effects may just have been delayed, so one should stay alert. But for now Fab Five Monetary Component is favorable for stocks.
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