December 2023


Cutting through hopes for 2024

State Street LIVE: Research Retreat offers a wide range of academic expertise and timely market insights.

State Street data shows that optimism about stronger than expected United States economic data this year should be tempered by forward-looking indicators that point towards a recession.

Analysis of the “US Economic Surprise Index” by State Street Global Markets shows the country’s economy has surprised on the upside approximately 90 percent of the time in 2023, while end of year growth expectations are more than twice what they were at the start of the year (and annualized third quarter Gross Domestic Product growth was nearly 5 percent), and core inflation has dropped to 2.4 percent.

However, the State Street Recession Likelihood Index, a model based on analysis of four key indicators – yield curve, equity market returns, payroll growth and industrial production – is currently suggesting an imminent recession is likely.

Speaking at State Street LIVE: Research Retreat 2023 in London, State Street Global Markets head of global macro strategy Michael Metcalfe described the past year’s economic performance as “Goldilocks” but said he and his colleagues remain “worried about recession” next year.

“Of course that’s all backward looking data,” he said. “Forward-looking indicators are still pointing to a high probability of recession.”

Showing the National Bureau of Economic Research’s metrics used to measure recession (personal income, payroll, wholesale trade, consumption, employment and industrial production), Metcalfe noted current personal income data is already close to the level it usually reaches at the start of a recession.

However, household consumption is the furthest of the six data points from its historic pre-recession level.

“It's credit growth and the reduction of excess savings,” he said. “That's exactly what's going on. Right now, US consumers, they're not spending out of current income, they're spending out of excess savings.”

“Compared to their pre-pandemic trend, we’re very close to, if not at the end of, them running down their excess savings after the pandemic. So, even though the current news is really good, that might be why you want to be concerned about the outlook on the cyclical side for the US.”

Metcalfe warned US investor behavior was beginning to support this idea, with flows out of the industrials, consumer discretionary and materials equity sectors, despite recent “gangbusters” growth in those areas of the economy, and flows into “all the classic safe haven sectors.”

“I think what this highlights is that even though the US growth story has been amazing this year, investors, to some degree, are ready for recession,” said Metcalfe.

Most analysts have reduced their expectations for a recession in the US next year and have similarly cut back on predictions for inflation risk. According to Metcalfe, the picture is less clear.

“The inflation outlook is still actually surprisingly quite uncertain, even though we think recession is coming,” he said. “This idea of inflation being sticky is still problematic. What does this all mean for rates? The tricky thing for markets though, all the way through, has been to gauge how quickly rates can come down.”

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