Where’s the recession?

0:06Pushkin. They say a recession is when your neighbor gets laid off. A depression's when you get laid off. But what if none of us get laid off? That's the question that an increasing number of folks on Wall Street have been asking recently. After, I don't know, 12, 18 months of everyone saying recession's three months away, what if it's not three months away?

0:32This is Unhetched, the new markets and finance show from the Financial Times and Pushkin. I'm reporter Ethan Wu here in New York, joined on Tuesdays by FT Markets editor Katie Martin. Katie, what are we doing here? I don't know. It's slightly terrifying and it's very exciting. But I think what we're doing here is talking about whatever we jolly well want to in markets and finance, whatever is the hot issue of the day, whatever is the big question of the day, we're going to try and unpack it for ourselves, frankly, and also for our listeners. Yes, kind of a live diary of what we're thinking about.

1:07Yes. And today it's the U.S. economy, Katie. I want to segment this discussion about the economy into kind of three sections, you know, strong, mixed, and weak, different types of economic data pointing different directions. Yeah. Because there's a lot of stuff in each bucket. We recently wrote over at the Unhedged newsletter, chopping up 11 different economic indicators into these three categories. And it was hard. I mean, there's a lot of edge cases. There's a lot of ones you can go either way. But we've picked three, I think, particularly clear data points to try to lay out kind of where we are.

1:39So let's start with strong. Katie, what is the strong part of the U.S. economy? Never bet against U.S. jobs numbers. Yes. And yet the market does every time, right? So every Friday, well, the first Friday of every month, we get the U.S. jobs numbers, the non-farm payrolls, the Mac Daddy of the econ data calendar, the number one thing that everyone in finance and markets watches. and every time Wall Street says, oh, we've got some jobs numbers, these jobs numbers are going to be terrible. It's about time we saw a real pullback in the jobs market because there's a recession coming, don't you know?

2:12And every single time this number just blows way past expectations and the smartest minds in the business seemingly cannot get payrolls anywhere close to right. This number's always been one that you can't guess. We used to have like a sweepstake in the office for payrolls. It's a really hard number to predict, but the pattern is clear. Wall Street is consistently underestimating the U.S. jobs market. And this is a major problem with the recession narrative because everybody knows, or do they, but everybody knows you can't have a recession without people losing jobs. And this just isn't happening.

2:46Absolutely. And I ran some numbers on this the other day, and it really surprised me how strong payroll growth is compared to kind of past expansions. So in the last three months, that would be, I believe, March through May, the average monthly job gain has been 280 ,000. During the 2010 to 2019 economic expansion after the financial crisis, the average was 180 ,000 jobs a month. So we're 100 ,000 above where we were in the last expansion per month. I mean, that is just really blistering. And any of the slowing – and we have gotten some slowing. It was stronger in 21. And I think you could say it was stronger in 22 as well.

3:20That's just cooling off from being red hot. That's not any kind of recessionary indicator at all. Yeah, but the fact that the market keeps saying effectively, we think this number is going to be bad and then it comes out good. That is the whole problem with markets now, right? So we've had a huge rally in the S &P 500 so far this year. Stocks are just like motoring higher and people are miserable about it. Everyone hates this rally. you know, any normal year, you'd see US stocks up whatever 12, 14 % and people will be like, well, hey, let's crack out the champagne. But this time, pretty much everyone I speak to is like, nope, this is going to end in tears, there's going to be a recession.

4:00I understand there hasn't been one yet. And that I've been saying there's definitely going to be one any minute now or year and it hasn't happened. But I swear there's going to be one. And there's just this real disconnect between certainly the jobs numbers and just the tone among every fund manager that you speak to. Yeah. And I think that tone kind of comes down to there is evident economic weakness right now. And that kind of takes us to the weak part of the economy. Really, the soggiest bit, unambiguously to me, is manufacturing, right? There's this monthly survey number put out by the Institute for Supply Management of US manufacturers, and it's been contracting for several months now.

4:39It's not quite yet in deep recession territory that takes several more months. But with every passing month, it looks more and more convincing that at least the good side of the economy, right? Not services, but the good side of the economy is in a sectoral recession. And I think you can tell a pretty convincing story about this, right? Everyone bought an air fryer, two Pelotons, and five PlayStations during the pandemic. You've been talking to my sister. Well, there was literally a PlayStation shortage, right? And America barely kept running. And I think you look at the data now, adjusted for inflation, demand for goods is flat, but then we have all this inventory buildup, right?

5:20We have still, you go to the warehouses and there's a bunch of stuff that you got to sell. And so retailers are having to do discounting, trying to get inventory out the door. And when you have flat demand plus an inventory buildup, that means the supply side has to shrink, right? There's no way around that. Yeah. And again, all things being equal in the long run, that should be bad for employment, but yeah, just not seeing it. But yeah, Yeah, clearly this massive inventory build that we saw a few months ago is really starting to bite now. And as you say, that sector is unambiguously in a certain amount of trouble.

5:52But what's in the middle? What's the kind of, eh, don't know? To me, the big mixed data point, the big question mark, the shrug, credit conditions. Are banks going to keep lending? I mean, it's only been like, what, three months since Silicon Valley Bank failed. And the question there has always been, is that kind of presaging things to come? Does that mean other regional lenders, other small banks that are facing competition for their deposits, does that mean they have to raise their drawbridges to stop extending credit? And once you stop the extension of credit, the party's over. Yeah. And interestingly, there's a similar sort of dynamic playing out in the corporate bond markets.

6:28So, you know, if you're a company and you want to borrow some money, yes, you can go to your bank and ask for some. Or you could go out into the public bond markets and see if you can find a bunch of investors to buy your debt. that market is like operating at quite weird different levels simultaneously so what bankers are saying to me is that if you're a good reliable safe company with a good credit rating absolutely knock yourself out you can definitely borrow money in the bond markets investors are looking for anything with a bit of yield they'll give you a relatively easy shake here if there is anything funky about your business if your rating has been cut if there's anything esoteric or niche about what you do.

7:06If you're on the sort of sketchier end of the high yield market, nah, the market is just closed to you. This is not happening. So on the face of it, this market is kind of operating fairly normally, but it's like, you know, a duck with its little flappy feet flapping away under the surface. There's a lot of hard work being done here to keep that market floating. Yeah. And I think it's worth just spelling out, right, that you talk about the bond market. I was talking about banks. These in some ways are kind of the same thing. There's credit being extended from a lender to a borrower to finance some kind of economic activity.

7:36And when that slows down, regardless of what market it comes in, it has ripple effects because, okay, that company doesn't have access to credit anymore. So they have a problem on their balance sheet. Maybe they have to cut costs by laying off people, by getting rid of office assets or whatever other way they can to lower their costs. And then if someone gets laid off or they have to sell an office building, well, that's someone else's income, right? And that ripples then again through the economy. But what we're not seeing, you know, certainly after Silicon Valley Bank went down, there was a lot of kind of hand wringing and people saying commercial lending is just it's in serious trouble here.

8:13This whole thing is just going to stop. It hasn't stopped. So there's something there for bulls and bears alike. Right. If you want to build a bullish case about the U.S. economy, you can say, look, SBB failed and it's all fine. If you want to build a bear case, you can say, well, it's coming. this massive pullback in lending from the banks. And also you've got a corporate bond market that's not in the best possible health. This is going to hurt. You can make that swing either way. So we've got employment strong, we've got manufacturing weak, and we've got credit conditions as this kind of big question mark about what happens next.

8:43But Katie, this is the Unhedged podcast. Let's not mess around. All right. I want to pin you down on when is the recession? Because there will be one. That's just a fact of financial capitalism is that you have downturns. When's it going to be, Katie? What would be your best guess? Let's do it in terms of quarters, because I think months is a little too hard. Quarters. Well, look, first of all, when's it going to be? I don't know. Some investors that I speak to are like, yes, I've been wrong about this recession. It hasn't landed yet, but maybe it's going to be a special sort of recession where people still have jobs and different bits of the economy will go into recession at different times and you might not even notice.

9:16Yeah, the so-called rolling recession, right? It's a very creative way of being wrong about your recession call that you had at the start of the year, and I respect it. I can't see it currently based on the jobs numbers. And look, I'm not Janet Yellen, Treasury Secretary. What do I know? But for example, I can't see the Fed cutting rates to deal with a recession until at the very least Q3 next year. I'm prepared to buy you a pint if I'm wrong. Q324. Yeah. Okay. Yeah. I think that's a good deal further out than maybe the Wall Street consensus right now. It's me and my pint versus Wall Street. Yes.

9:55You're going to have to buy all of Wall Street a pint. I think if I remember this correctly, I believe in that over the next 12 months, the probability of recession is about 60%. So maybe, you know, two and three chance of recession in the next 12 months. And Katie Martin says, no, no, it's going to be more like 18. And I put a pint on it and everything. And you put a pint on it. What about you? What are you saying? I think I'm very conventional on this. Though I will say, you know, I did expect initially, maybe if you asked me six months ago, I expected the fourth quarter of this year, somewhere around then would be when you'd see the recession.

10:25Just we've gotten enough strong economic data, especially on that employment picture in the last couple of months. And also other sectors like housing, which was, I think, long, a really worrying soft spot in the economy where just no one was buying or selling houses at all because mortgage rates had just absolutely blown through the roof. And now that seems to be bouncing back a bit. Some people got to move somewhere. Right. So I think it's been pushed out a bit. Maybe Q1 24 is my best guess, probably toward the end of Q4 on a month to month basis. Who can really say? And would you buy me a nice glass of Merlot if you're wrong?

11:03Done. We'll be back in a minute with Long Short.

11:13Welcome back. This is long short, that part of the show where we go long in favor of something and short against something. And it can be pretty much anything. It can be a stock we like or hate, an idea we like or hate, a newspaper company we like or hate. Whatever it is, we go long one thing, short one thing. A newspaper company? That was random. And Katie, I am long the Three Arrows Capital guys. This is pure trolling, Ethan Wu. Hear me out. Hear me out. All right. So for people that don't know, it's Suzu and Kyle Davies. They ran this. People call it a crypto hedge fund. It's not really a hedge fund.

11:52But they ran this investment office that bought a lot of crypto and took a lot of people's money to do it. And then when crypto prices turned over and one particular nasty project blew up, Three Fero's capital failed miserably and the entire crypto market collapsed because of these two guys who were friends at Colombia. But please don't worry about them, Ethan, because they're having a very nice time in Bali, according to the newspapers. According to the New York Times, they are having a great time in Barcelona and Bali. And I am long them because, you know, they understood the assignment. They knew what was up.

12:24They saw this inflating bubble and they cashed in. And if they're lucky and if they've done their homework right, they'll escape it with no legal punishment. I'm not long them ethically, but as far as finance goes. Homework, ethics, okay. You could be long of that. I also wanted to be long of something. Is that okay? I want to be long something as well. I want to be long US stocks. The market just keeps motoring higher. And the reason why I think it's going to keep on motoring higher is partly because everybody hates it. This is such a hated rally. And this is just a perfect way to annoy people who work in investment for a living.

13:01I think people keep looking for that point when they're going to turn over, when the big five stocks are going to hit a wall and it just keeps not happening. Maybe we just need to accept that this is a thing and go with it. Yes. I am short us having two longs on our first edition of Long Short. But I mean, then again, we are the unhedged podcast. So I think a double long position is appropriate. Unhedged by name, unhedged by nature. That's right. We've really drunk the Kool-Aid on this. That's right. Katie Martin, thanks so much. We will be back on Thursday with another episode of the Unhedged podcast.

13:33Catch you then.

14:05Our theme is by Stellwagen Symphonette. I'm Ethan Wu. Thanks for listening.