Are U.S. recession risks decreasing?

Executive summary:

  • U.S. recession risks look lower, but still elevated compared to normal
  • We believe a recession is still more likely than not in Europe and Canada
  • U.S. consumer prices rose slightly more than expected in December

On the latest edition of Market Week in Review, Investment Strategy Analyst BeiChen Lin and Equity Manager Research Analyst Michelle Batjargal discussed the probabilities of a recession in the U.S. and around the world. They also provided an update on the latest U.S. economic data, including recent inflation and nonfarm payroll numbers.

Russell Investments lowers U.S. recession risk to 45%

Batjargal and Lin opened the conversation with a look at the latest U.S. recession probabilities, which Lin said appear lower than before. Since the publication of Russell Investments' 2024 Global Market Outlook in early December, a few important developments have taken place, he explained, including a new emphasis by U.S. Federal Reserve (Fed) officials that the risks of tight monetary policy are two sided.

"Recent remarks on this topic represent a clear shift in sentiment from the Fed. Before, the central bank was squarely focused on corralling inflation by lifting rates. Now, the Fed is acknowledging that it also doesn't want the U.S. economy to slip into a recession due to high borrowing costs," Lin stated, adding that Fed officials are projecting three rate cuts in 2024.

He said that with the U.S. central bank pivoting to a more dovish stance and the economy continuing to be more resilient than envisioned, the strategist team at Russell Investments has decided to decrease its U.S. recession probabilities from 55% to 45%. Although the number is lower, Lin stressed it's still a significantly higher number than the typical recession risk that exists in any given year, which he said is around 15%-20%.

"To be clear, we still think recession risks in the U.S. are elevated, and stress that investors need to be mindful of these risks. Even though we've seen relatively painless progress to date when it comes to the Fed's inflation fight, the last and final stretch of battle may prove to be the most challenging," he stated.

So, how does the strategist team's revised forecast impact Russell Investments' market views? The team believes that not a lot of recession risk is being priced into markets right now, with many analysts expecting that the S&P 500® Index will end 2024 at around 4,800. "Our view that there's a 45% probability of a U.S. recession looks to be much higher than what markets are anticipating. As such, we're very hesitant about celebrating too early, and aren't looking to chase into any short term equity market rallies. At this time, we still think it's better to be disciplined and stay close to our strategic asset allocations," Lin concluded.

Is a recession still more likely than not in Canada? What about in Europe?

Next, Batjargal asked Lin how the team's reduced U.S. recession forecast impacts the probabilities of an economic downturn in other parts of the globe. Lin said that on one hand, the interconnectedness of the global economy means that lower recession chances in the U.S. are a slight positive for economic outlooks in other countries. On the other hand, however, recession probabilities are also highly dependent on idiosyncratic factors specific to each country, he said. "These include a country's local growth rates, central bank policy dynamics and inflationary backdrop," Lin stated.

Focusing specifically on Canada, Lin noted that economic data there is significantly weaker than in the U.S., while the Bank of Canada's preferred core inflation measure continues to run slightly higher than the Fed's preferred inflation gauge. "Looking at the totality of the country's economic environment, we believe that a recession in Canada is still more likely than not," he stated.

Lin added that the strategist team believes recession risks in Europe also remain elevated, with leading economic indicators such as the PMI (purchasing managers' index) continuing to show signs of weakness.

Unpacking December's U.S. inflation and employment reports

Batjargal and Lin wrapped up the segment with a look at the latest U.S. economic data, including labour market and inflation numbers from December. Lin said that job creation last month was somewhat stronger than anticipated, with the economy adding 216,000 jobs. He noted that many of the new jobs were in so called catch up sectors like healthcare, leisure, hospitality and education areas of the economy where total employment remains below pre pandemic levels. However, there was also a slight broadening of job creation into a few other sectors, such as construction, Lin said.

"As 2024 unfolds, what the Fed wants to see is the labour market coming better into balance, with job creation not as strong as before and job gains more broad based, rather than concentrated in a few sectors," he remarked.

As for inflation, Lin said that the core CPI (consumer price index) climbed 3.9% on a year-over-year basis in December, which was slightly above analysts' expectations for a 3.8% increase.

"Ultimately, both the jobs and inflation numbers are a reminder that while the Fed has done a lot of great work in taming inflation, there's still room to go before victory is declared," Lin concluded.

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