Comparing Mild and Deep Recessions
The July CPI report came out this week, and the headlines were positive and below expectations. The market’s initial reaction was overwhelmingly positive as the inflation slowdown reignited hopes for a peak in inflation and potentially a Fed tightening slowdown. Is the market’s reaction justified? Based on the headline reading, a case can be made that inflation is easing and the Fed could slow its tightening pace. However, a closer look at the underlying data indicates that it is too early to tell. Is the Fed going to hang a Mission Accomplished banner at Jackson Hole or the September FOMC meeting? Highly doubtful. The cooling inflation pressures were driven by Apparel, Appliances, Used Vehicles, Hotels, Car & Truck Rentals, and Airfares. In contrast, Furniture, Housekeeping Supplies, New Vehicles, Beverages, Primary Residence Rent, Vehicle Repairs & Insurance, and Food all increased. The categories the Fed is most concerned about are still rising, and there is not yet enduring evidence inflation is receding. Still, the slight CPI reprieve was welcomed.
Zooming out, the top debate in financial markets is still whether the U.S. is in a recession. Data released the last week of July showed the U.S. real GDP growth shrank -0.9% q/q during 2Q22 following a -1.6% q/q contraction during 1Q22. The two consecutive quarters of negative GDP growth meet the technical definition of a recession and provide support for the pro-recession group. The other corner of the market claims the U.S. hasn't entered a recession ... yet. If there was a recession during 1H22, our inclination is to refer to it as a mild recession caused by overstocked inventories and an overheated housing market. Job growth was far too strong to trot out the capital R 'Recession' term.
However, does it really matter whether 1H22 was a recession? It feels like the market is debating a topic that really doesn't matter. The U.S. and global economies are clearly slowing with no catalyst to reverse the slowdown, and central bank tightening operates with a lag, meaning the current slowdown doesn't fully reflect tighter policy yet. To develop an investment framework, this report compares mild and deep recessions over the past 100 years. History leads us to a patient, data dependent portfolio approach.
