Vested Intelligence recently called attention to a telling survey of chief financial officers (CFOs). Every one of the 22 respondents, all from major corporations, anticipates a recession in the United States within the next 12 months or so. None believe that Washington or anyone else can do anything to avoid this ugly prospect. Accordingly, they also anticipate that stock prices will fall farther, bringing to almost 30 percent the overall loss from market highs of earlier this year, about the average adjustment when a recession is in prospect. It is far from a happy outlook but one with which this column agrees, as regular readers already know.
The survey’s writeup only hints at why the CFOs have reached their stark conclusion. Respondents have clearly rejected the easy excuses still being offered by the many authorities in Washington. Only some 9 percent of these executives see the fallout from Russia’s invasion of Ukraine as a major factor in the outlook, and only slightly more, 14 percent, see supply-chain disruptions in that light. The overwhelming majority of respondents – some 64 percent — identify inflation and the Federal Reserve’s (Fed’s) response to it as overriding concerns. These assessments jibe with the way earlier discussions in the space explain how inflation and the Fed’s counter-inflationary efforts lead inexorably to recession.
Fed action is the most direct route. Even before the Fed abandoned its earlier monetary stimulus last March, the stage was set for an economic slowdown if not a recession. The fall in the first quarter’s real gross domestic product (GDP) might have been more technical than fundamental, but slowdowns in consumer and business spending were already evident during the second half or 2021. Now the Fed, in response to the demands of inflation, has added to the forces of economic restraint. It is draining liquidity from financial markets and already raised short-term interest rates 1.5 percentage points, bringing up the benchmark federal funds rate to about 1.75 percent. Policy makers promise more to come. Longer-term bond yields have risen in response. The yield on 10-year treasury bonds has more than doubled from where it was this time last year to just over 3 percent recently.
Alone such yield increases are not sufficient to bring on a recession or cause further stock market erosion, but they are not the end. The CFOs referenced the further rate hikes promised by the Fed, suggesting that the pressure will ultimately bring 10-year yield treasury yields up to over 4 percent by year end. That is optimistic in today’s inflationary reality. For the Fed to stem today’s inflation, policy makers there will need to bring the yield on these long treasuries up closer to 8 percent or more, if not by year end, then ultimately. That is nearly triple today’s levels. That kind of a rate move could easily bring on recession and cause at least as much stock price erosion as the CFO’s anticipate.
Nor will the economy avoid recession if the Fed returns to its old timidity and refuses to take these necessary steps. Failing to do its job will only intensify the economic distortions that grow out of inflationary pressures – misallocated investment dollars, wage-price spirals, and the like. These distortions will create recessionary pressures quite independently of the Fed. What is more, as lenders of every sort demand rates and yields that at least compensate them for the dollar’s loss of spending power, interest rates of every maturity will rise even if the Fed fails to act assertively. Both forces will create a strong recessionary push. An economic downturn based solely on these forces might develop later than if the Fed actively and promptly does its job, but its duration and severity would almost certainly be worse. The stock market would, of course, immediately respond to such a rise in rates and yields and also suffer in anticipation of the ultimate and more severe recessionary effects.
More than half the CFOs – 54 percent – believe that the Fed will take the necessary steps and will stem the inflation, even if they underestimate the ultimate size of the necessary interest rate increase. If that still does not spare the nation recession, and it will not, it would produce something less severe and less lasting than if the Fed fails and the economy is left to suffer the recessionary effects of unchecked inflation. A diligent Fed does not produce a happy prospect, but still a better one than the alternative of an insufficiently active Fed.