 This is an excerpt from our July 6, 2023 Morning Briefing.
Let’s revisit our upbeat response to the most frequently cited reasons to be worried about a recession:
(1) Falling leading indicators and M-PMI. The Index of Leading Economic Indicators (LEI) peaked at a record high during December 2021 ( Fig. 7). It is down 9.4% since then through May. The LEI correctly anticipated the previous eight recessions with an average lead time of 12 months.
We’ve previously shown that the LEI is biased, giving more weight to the manufacturing than the services sectors of the economy. The y/y percent change in the LEI (which was down 7.9% in May) closely tracks the M-PMI (which fell to 46.0 during June) ( Fig. 8). Both are consistent with our rolling recession scenario, with the recession currently rolling through the goods sector. That’s confirmed by the weakness in the ATA truck tonnage index and railcar loadings of intermodal containers over the past year ( Fig. 9).
(2) Inverted yield curve. Melissa and I “wrote the book” on the yield curve in 2019. It is titled The Yield Curve: What Is It Really Predicting?. We concluded that inverted yield curves signal that investors believe that the Fed’s continued tightening of monetary policy would result in a financial crisis, which could turn into an economy-wide credit crunch and recession. It is credit crunches that cause recessions, not inverted yield curves that anticipate these events.
This time, the yield curve inverted last summer. It once again correctly anticipated a banking crisis, which occurred in March. What is different this time, so far, is that the Fed responded very quickly with an emergency bank liquidity facility, which has worked to avert an economy-wide run on the banks and a credit crunch, so far ( Fig. 10).
So there has been no recession, so far. There still could be if the banking crisis slowly turns into a credit crunch. That’s why Melissa and I are closely monitoring the weekly commercial banks’ balance-sheet data ( Fig. 11). They show that bank deposits peaked at a record $18.2 trillion during the week of April 13, 2022 and fell to $17.3 trillion during the June 21, 2023 week. Yet bank loans remained at a record high of $12.1 trillion during the June 21 week. Banks held a record $5.8 trillion in securities during the week of April 13, 2022. This sum has dropped by $645 billion to $5.2 trillion as the securities have matured. Banks are using the proceeds to offset the weakness in their deposits and to make loans.
(3) Declining M2. Monetarists seem to be making a comeback, and they are sounding the alarm that the recent weakness in the M2 measure of money is confirming that monetary policy already is tight enough to cause a recession. We’ve addressed this issue in the past, and we still aren’t alarmed.
The money supply as measured by M2 climbed $130.9 billion in May after falling the prior nine months by $1.0 trillion ( Fig. 12). It is down $897 billion since it rose to a record high during July 2022. It is down 4.0% y/y. However, M2’s decline follows a $6.3 trillion (41%) increase from January 2020 (just before the start of the pandemic) through its record high. M2 still remains about $2 trillion above its pre-pandemic uptrend!
As we noted above, the weakness in bank deposits has been partly offset by the proceeds from maturing securities held by the banks. Meanwhile, demand deposits in M2 totaled $5.0 trillion during May. We reckon that’s $1.5 trillion above the pre-pandemic trendline in deposits. Demand deposits currently account for 24% of M2, up from 10.3% during January 2020 ( Fig. 13). M2 hasn’t been this liquid since September 1972!
(4) Running out of excess savings. The yearly change in M2 has been closely tracking the 12-month moving sum of personal savings, suggesting that there’s still plenty of excess savings left based on our analysis of M2 above ( Fig. 14).
This conclusion is confirmed by Fed data on the ownership of deposits plus money market funds by generation cohorts. Here are their Q1 holdings and the increases since Q4-2019 in these liquid assets: Silent ($2.6 trillion, -$65 billion), Baby Boomer ($8.9 trillion, +$2.5 trillion), GenX ($3.9 trillion, +$1.1 trillion), and Millennial ($1.6 trillion, +$625 billion) ( Fig. 15).
Again, we reckon that the excess liquid assets held by the Baby Boomers alone ranged between $1.0-$2.0 trillion at the end of Q1.
(5) Tightening monetary policy. Monetary policy is restrictive, especially considering the tightening of lending standards in reaction to the March banking crisis as well as the ongoing QT program. However, tight monetary policy has been offset somewhat by very stimulative fiscal policy. In the past, fiscal stimulus usually occurred at the tail end of recessions or even once they were over. This time, plenty of fiscal stimulus has been enacted before the next recession. That’s another reason why the next recession has been a no-show so far.
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