Amidst the build-up to the 2023 recession, in 2022, the Fed hiked interest rates 7 times in a row in response to worrisome inflation, marking the fastest hike cycle in history. Now, rates sit at a 16-year high. Historically, such tight monetary policy precedes a downturn.
However, the widely-anticipated 2023 recession remains notably absent, with markets soaring back up. This economic riddle warrants more profound analysis. One explanation lies in the concept of time lags in macroeconomic indicators. The unfolding economic situation may simply be experiencing longer-than-usual time lags, pushing back the onset of the anticipated recession.
Unpacking the Economic Indicators
The National Bureau of Economic Research (NBER) leverages several indicators to discern a US recession. Over the past year, a majority—industrial production, averages of GDP & GDI, real personal income excluding fiscal transfers, and real manufacturing—have been either stagnant or pointing toward a 2023 recession.
Paradoxically, employment and real consumption continue to exhibit growth, illustrating the resilience of the consumer and labor markets. This is being driven, in part, by corporate cost-cutting measures. That said, projections suggest a potential further contraction in earnings, leading to layoffs.
The relationship between these indicators and actual economic performance isn’t simultaneous; a time lag can vary significantly (historically up to 3 years). The apparent extension of these time lags in the current economic cycle offers a potential explanation for the yet-observed recession.
Consider the yield curve, which reflects the difference between short and long-term interest rates. An inversion in the yield curve, where short-term rates exceed the long-term ones, often signals a looming downturn. However, the lag between such an inversion and the actual onset of a recession has varied in the past.
For instance, a persistent curve inversion took 18 months to translate into a recession in 1990, only 12 months in 2001, and 21 months in 2008. Data from 1978 shows that a recession occurs, on average, 22 months following an inversion. With this cycle’s yield curve first inverting in April 2022, this data implies that a recession will likely occur by February 2024.
A similar lag exists between interest rate hikes and recessions. On average, it takes 10 months after peak interest rates for a recession to occur and 21 months for stocks to reach their bottom. Keep in mind that we likely haven’t yet hit peak rates. If rates peak by December 2023, this implies a potential recession date of October 2024.
Between these significant indicators, historical lags predict a downturn around mid-2024: Further out than most pundits had predicted but still firmly within the horizon.
Credit Time Lags Add to Delay of Potential 2023 Recession
Credit time lags may also contribute to the predicted 2023 recession’s delayed onset. A low-interest-rate environment coupled with tight credit spreads led US companies to increase their borrowing significantly in 2020 and 2021, mainly through long-term corporate bonds.
Consequently, in 2023, high-yield and leveraged loan issuers deal with minimal refinancing needs. As an Alliance Bernstein report notes, there’s “no approaching maturity wall that would force companies to issue debt at higher prevailing rates.”
The typical credit crunch of a recession, thus, gets postponed until these companies are forced to refinance at higher rates, potentially causing bankruptcy or business contraction.
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