Why So Many Investors Think a Recession Coming

Looking for Volckerization

When the Fed started raising rates last year, many investors thought it would be a repeat of the rate raising efforts of Fed Chair Paul Volcker in the early 1980s.  People are always more comfortable with a repeating pattern since it is easier to understand.

However, nothing could be farther from the truth.  There are huge differences between now and then.  First, the Fed cannot possibly raise rates into the double digits or it would pop the bubble economy – not merely cause a recession.  The stock, bond and real estate markets were priced so low that they could handle double digit rates in 1980. Not anymore.  The Dow is at 35,000, not 1000 as it was in 1980.  

Second, the hope is that the Fed could do a big, short, sharp rate increase, like Volcker, and get rid of inflation for decades and then quickly lower rates again to keep stock, bond and real estate markets in a big upswing.  We would endure a big, short recession and then return to low interest rates.

Not going to happen this time.  As just mentioned, the Fed can’t raise rates like Volcker did or they would pop the Bubble economy.  So, they certainly can’t raise rates enough to eliminate inflation. Instead, they can’t raise the 10 year rate to much more than 5% or 6% and they won’t be able to sharply decrease rates because inflation is still a concern, plus they will have to print money to fund the annual $2 trillion deficits.  

This is all very different from what was possible in the early 1980s. And not what investors want to hear. They want what Volcker did – a short, sharp increase in rates followed by a big drop in rates which means a short sharp recession followed by boom times.

Hoping to Save the Bond and Real Estate Markets 

A short, sharp recession caused by rate increases followed by a return to lower rates is just what the bond market needs to recover.  Same for the real estate market.  If the Fed doesn’t lower rates (as it did in the Volcker situation) bonds are screwed.  They will have taken the biggest bond loss in history and NO REBOUND.  

The same is true for real estate – prices of both residential real estate and commercial real estate will be under continuous pressure if mortgage rates stay high.  Interest rates must come down or real estate prices definitely will come down.

Hence, a big recession that requires the Fed to quickly lower rates is just what the bond and real estate markets need.  That’s why many investors would lek to see a recession.  But, again, not going to happen for reasons just explained.

Ignoring Massive Congressional Stimulus 

Finally, you would expect to see some kind of recession when the 10 year rate moves from 1.5% to 5%.  The fact that there isn’t even a small recession is a little unsettling.  What’s going on?  It doesn’t make sense!

True it makes no sense if you ignore the massive stimulus being put into the economy by the US Congress.  Most, if not all investors, don’t want to see how important the massive stimulus is because it is prima facie evidence that we are in the midst of a massive bubble economy.  That’s something that even the biggest bears don’t seem to admit.

Last year Congress DOUBLED our annual borrowing from $1 trillion to $2 trillion.  This year, they will likely increase borrowing by another $300 billion (or more) to $2.3 trillion.  We are nearing the all-time peak of stimulus that we hit in the Covid Crisis!  All terrible in the long term – all a big plus in the short term.

Growth Will Slow, but No Big Recession 

Just because we likely won’t have a big recession doesn’t mean we won’t see slower growth.  We will clearly see slower growth of maybe 1.5% in the 4th quarter of 2023.  That's way down from almost 5% growth in the 3rd quarter.  We will also likely see somewhat slower growth next year than this year.  But, like this year, I think it is quite possible growth will surprise to the upside.  

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