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    Lending | 3 min read

    Recession is on the horizon. Is your institution prepared?

    While there has been discussion for months about the possibility of recession late this year or early next, until early July, this was far from certain. However, recent higher inflation data and monetary policy action has made the probability of recession exceed 90%. The only questions now are when it will start, how long it will last, and how severe it will be.

    In this blog post, I’ll provide insights regarding what the contours of the recession and subsequent recovery might look like.

    Current Economic and Financial Landscape

    Even though the second quarter GDP came in at -0.9% for two straight quarters of negative GDP, we aren’t technically in a recession, yet. 

    The National Bureau of Economic Research lists six factors it considers when defining whether or not a recession has occurred:

    • Non-farm payroll employment
    • Industrial production
    • Real consumption
    • Real sales
    • Household employment
    • Real income (less transfer payments)

    As a general rule, these measures tend to be negative after two consecutive quarters of negative real GDP growth (the rule of thumb definition of a recession). Whether we are in a technical recession or not is a nuanced argument without much benefit to consumers and businesses who are both feeling the effects of a slowing economy and high inflation. What we do know is that growth in economic activity is slowing, quickly approaching “stall speed.” 

    Economic Outlook: What Type of Recession Are We Headed Toward?

    With most indicators signaling recession, it is our view that one within the next 12 months is more than 90% likely. The primary question is whether this will be a mild garden variety recession or something more painful.

    The Case for Deeper, Longer Recession

    Some prominent economists are calling for another deep recession. Their primary case is built on the amount of public and corporate debt that has been amassed in the past few years in both the developed and developing world.

    While it is true that debt levels have increased to historically high levels, it is not clear we are headed for a credit event like what touched off the financial crisis. 

    For starters, financial institutions have much lower levels of debt (thanks to tighter regulation) and are in much better shape to weather am economic downturn. Fortunately, most U.S. institutions do not have the exposure to emerging market debt like we saw in the 1980s. 

    Lastly, the Fed learned a lot from the financial crisis that positions it well to prevent a repeat of 2008.

    The Case for Mild Recession

    Given the relative strength of the financial industry and labor markets, the case for a milder recession seems more probable.

    We have had jobless recoveries after past recessions in which job markets took a while to improve after economic growth rebounded. This time, we are likely to see a “jobfull” recession in which the opposite occurs. 

    With nearly two vacant jobs for every unemployed person in the U.S., the labor market is historically tight. Employers have had such difficulties attracting and retaining workers, many will hold on to them as long as possible even as the economy turns downward. Instead of the unemployment rate jumping up to 7-10% as we see in most recessions, this time may see a peak around 5.5-6%.

    With fewer Americans losing work than in normal downturns, the economy will likely have a milder and shorter recession than typical. In turn, this will mean fewer defaults and foreclosures for the financial system to grapple with and, thus, less likelihood of a larger credit event or financial crisis.

    Overall, economic growth may contract by 2-3% for a period of 2-3 quarters. If inflation stays higher than expected, this could protract out to four quarters as the Fed will have to leave rates elevated for longer. In short, the recession will last as long as elevated inflation keeps the Fed’s foot on the brake pedal.

    In fact, we would not be surprised to see the Fed lowering rates by the second half of 2023 in order to reverse the economic downturn and begin the move back to a more neutral level of monetary policy, a Fed Funds rate in the 2-2.5% range.

    Recovery

    As the economy enters recovery, we fully expect the job market to tighten quickly once again. Any slack (unemployment) caused by the recession will be quickly reabsorbed. Employers will once again be challenged to find workers within a few quarters of the end of the recession. 

    Economic activity will likely return to pre-recession levels within three quarters from the end of the recession (mid-2024). Expansion beyond that will likely return to long run sustainable levels of annual growth of 1.5-2%. Demographic challenges will once again curtail growth outlooks as labor force growth remains subdued well into the future.

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    Blake Hastings

    Blake Hastings joined SWBC as Senior Vice President of Corporate Strategy and Chief Economist in July 2021. In this role, he provides leadership in the areas of corporate development and long-term growth strategies. He also supports our business development goals and activities by leveraging external relationships in both the public and private sectors. Additionally, Blake provides direction in the assessment, evaluation, and management of risk throughout the organization. Prior to joining SWBC, Blake worked for the Federal Reserve Bank of Dallas for over 14 years. He served as a Senior Vice President overseeing the San Antonio and El Paso branch offices.

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