The Crash Landing into a Marshmallow: Are We Heading Toward Recession

During their recent episode, Taylor, Carlisle, and Steve Hou discussed The Crash Landing into a Marshmallow: Are We Heading Toward Recession. Here’s an excerpt from the episode:

Tobias: Let’s start with, where are we in the economy? How do you see it? Are we in a recession? Is there a recession approaching? Have we had a growth scare? Is this what always happens in the lead up to an election? What’s your sense?

Jake: Climbing the wall of worry?

Steve: I think we are living through, for something cliche, the most extraordinary macroeconomic episode in modern history. I don’t think we are in a recession. We’re definitely not in the recession right now, and there are very many indicators we can point to just say that. But I also don’t think that we’re not at danger of getting into some a sharp economic slowdown that end up in a recession if we’re not careful or lucky.

Jake: Steve, can I ask– Would we be in a recession now if we weren’t running trillion-dollar deficits?

Steve: That is a very difficult question to answer. [chuckles] With macroeconomics, there’s so many confounding variables. I know what you’re getting at. There’s just no question that broad strokes. I think there is something to the effect of the Fed having acted too late, the federal government having issued too much money, fiscal stimulus between the two presidents, and then, the Fed having to then come back and perhaps overcorrect that the two things offset each other. We crash landed into a marshmallow.

[laughter]

That’s how I like to think about it. Because we fell so hard, that we’re crash landing into a big piece of marshmallow so fast, so forcefully, what the end outcome depends a little bit on the thickness of the marshmallow, and the speed and momentum with which we’re going to fall and crash. We are trying to arrest the momentum a little bit with the Fed now starting to talk about starting to cutting rates and so on. So, that’s where I think we are.

I think we are going through some episodes of growth scares. We already saw one. Last month, we saw the job numbers came in very low. And then, it almost was like what economists call like a peso problem where it’s not news. If you look at all the indicators, the ones that matter, the ones that I watch, which basically is the labor market, which is the only one that really matters, forget about everything else. Whether it’s job openings, whether it’s a higher rate, like how many people being hired, the quick rates, how often people are quitting their jobs? Unemployment rate has been kicking up steadily from a very low level, albeit.

Wage growth has been steadily slowing. In other words, no matter where you look, the economy has been steadily slowing. It’s just the last month, I think everyone got a sudden wake up call, “Wait a second, hold on. We may actually be entering recession.” It’s funny enough is because of this indicator that has become famous by my fellow new Michigan Alumnus, Claudia Sahm. She was a few years ahead of me.

She invented, when she was at the Federal Reserve, this rule called the Sahm Rule, which says, if you look at the rolling three months, use three unemployment rate increase and if it bridges 25%, historically, it has always been followed by further increase in unemployment rate and the recession. And everyone suddenly just saw that indicator being triggered and say, “Oh, wait, we’re going to be in the recession, market sell off,” which coincided with this Japanese shortfall carry trade blow up, and everything happened at once. But then, we obviously have to come on the other side of it, like you snapped right back.

Jake: That was a scary 10 minutes there.

[laughter]

Steve: Yeah, that was basically one episode of a growth scare. I think we may still have more, but we also, I think going to have conflicting indicators. Since the job report, we’ve had retail– We have continuous claims, essentially for people who are on unemployment insurance. We are seeing signals that maybe the economy is actually stronger than certain numbers indicate. I think we just have got a lot of confluence of different factors, because a lot of the aggregate statistics are a little bit screwed up during the pandemic.

All these numbers that we see, they all come from surveys of either households or companies. Unemployment comes from survey of households, and payroll survey comes from survey of companies. All of these surveys are being responded to with a much lower percentage. It turns out people are suddenly realizing, “Wait a second, there’s this single pandemic. I die any moment. I’m not going to just fill out some long questionnaire for nothing.”

And yet, on top of that, the most prominent political issue across all countries today is illegal immigration. It turns out if you have illegal immigrants that are here in this country and working to support themselves in one form or another, they probably won’t be reached by a household’s mail survey, because you don’t know where they live. [chuckles]

Even with companies which may report them as part of payroll, may not be fully reported because companies may not always want to report how many people they are hiring that may or may not be fully compliant. So, you just have a lot of noise in these aggregate statistics. That’s why we’re almost experiencing a mini version of, what I call, the March 2020, where we are whiplashing a little bit based on noisy little crumps of data, because on the other side, the uncertainty is enormous.

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