Will the US economy collapse into a recession in 2024?

The United States’ economy, a $27 trillion juggernaut representing 25 percent of the world’s GDP with an income of $80K per capita, is the largest in the world.

Which direction the US economy moves affects the world as a whole. Thus, whether the American economy will collapse into a deep recession is of great interest to governments, corporations, consumers, savers and investors worldwide.

If the US economy does slip into a deep recession, the country would face higher unemployment, lower corporate profits and lower stock prices. This would translate into fewer imports by the US, and thus fewer exports from the rest of the world to the US, as well as lower benchmark interest rates globally, meaning the effects of lowered economic activity in the US would be felt worldwide.

However, recessions in the US are relatively infrequent events (only three in the last 30 years), and the weight of the current evidence suggests that a recession in 2024 is still a pretty low-probability event.

For the last three-and-a-half years, the US has been grappling with the policy responses to COVID, which have caused a massive inflation problem, peaking at 9.1 percent in July 2022. While the US Federal Reserve appears mostly done with raising interest rates to tame inflation, when and how far the benchmark Fed Funds Rate will start declining is still uncertain.

One scenario is the "soft-landing narrative," where the Fed can begin reducing rates further without reigniting inflation or causing a recession. Most recent developments give some support to this soft-landing narrative.

Third quarter annual GDP growth in 2023 accelerated to 4.9 percent (up from 2.1 percent in the second quarter). Average hourly earnings increased by 0.4 percent in October.

Full-time employment and average hours worked were steady. Corporate credit spreads have fallen gently over the past six months (BB-rated corporates are at 6.09 percent while CCC-rated corporates are at 12.81 percent, indicating a low recession probability as of December 24). Under this narrative, the economy continues to expand modestly, corporate earnings hold up, and stock prices remain elevated or rise further while inflation is gradually brought under control.

The alternative narrative is that given the long and variable lags between monetary tightening and the real economy, the Fed’s steep rate hikes over the past two years may have already engineered a recession. There are many signals consistent with the possible recession scenario as well.

First and foremost, the Conference Board's Leading Economic Indicators have fallen 18 months in a row and are flashing a potential recession signal.

Other early recession indicators include a steady decline in Consumer Price Index (CPI) inflation from 9.1 percent to 3.1 percent, five-to-six expected rate cuts by the Federal Reserve during 2024, a weak reading for Manufacturing PMI, and an increase in consumer loan delinquencies from 1.55 percent in the fourth quarter of 2021 to 2.53 percent in the third quarter of 2023, representing the highest level in 10 years.

There’s also been lower annual corporate profits ($3.59 trillion in Q3 2023, down from $3.7 trillion in Q2 2022), layoffs in tech, automotive, healthcare, finance, and service sectors, and a massive inversion of the yield curve (5.54 percent for the 1-month T-Bill versus 3.9 percent for the ten-year T-Note or a 164 basis point inversion as of December 24).

Even some currently strong economic signs, such as the most recent GDP reading at 4.9 percent, are worrisome as they may signal higher future inflation and an even stronger future reaction to further Fed tightening. The unemployment rate is 3.7 percent, near a historic low, creating concerns about the extraordinary strength of the labour market, which is still very tight.

The most recent numbers are 199,000 new payroll jobs added in November, 1.5 job openings for each person looking for a job, and a labour participation rate of 62.8 percent (still 0.6 percentage points below February 2020 numbers).

Counter-balancing this argument is the weakness in the banking sector and the concomitant credit restriction. In this second narrative, either the economy will continue to roll over gradually or higher eventual Fed Funds rates will break something, pushing the economy into a recession.

Then, there are the deep recession risks that can come from major shocks. The inflation-induced banking crisis is not over, as the March 2023 FDIC takeover and subsequent firesale of First Republic Bank to JP Morgan Chase indicates.

It is just staying dormant. Academic estimates show that the banking sector is sitting on $2.2 trillion in unrealised losses, bigger than the aggregate value of the equity of all banks. Furthermore, 10 percent of banks have seen larger unrecognised losses than Silicon Valley Bank, forcing banks to cut back on credit and raise loan interest rates.

Moody's recently downgraded 10 small and mid-sized banks, and Commercial and industrial loans have declined about 8.6 percent from their pre-Covid peak of $3.034 trillion in May 2020 to $2.774 trillion in October 2023. Continued credit contraction can trigger a deep recession. While the possibility of a run-on-deposits causing a banking crisis seems to be in the rear-view mirror, a continued, deep credit-contraction-induced recession is not out of the question.

To reconcile these contradictory signals, I prefer to pay attention to what the top-level corporate executives in all publicly listed US corporations think and do. By law, top-level executives in the US must disclose all of their buying and selling decisions in their own companies on a timely basis.

Over 60 years of academic research have shown that top-level corporate executives in more than 6,000 publicly listed firms are the best informed of all market participants. In general, when top-level corporate executives are optimistic about the economy's future direction, they buy shares in their own companies.

Conversely, when top-level corporate executives are pessimistic about the economy's future direction, they generally sell shares in their own companies. In contrast to the many economic statistics, top-level executives' buying and selling decisions have real wealth consequences for their own families. Hence, looking at whether the top-level corporate executives are buying or selling shares can inform us about the future direction of the US economy.

Data from InsiderSentiment.com shows that corporate executives are pretty sanguine at this time. Starting in September 2023, top-level executives turned optimistic about the US economy and have remained optimistic. Based on the recent top-level executives’ trading decisions, there is no sign of a US recession, at least in the near term.

Top-level executives show above-average aggregate stock buying activity, especially buying value stocks, defensive stocks, small-cap stocks and laggards. Their trading is neutral in cyclical stocks. The overall evidence suggests that the top-level executives expect a mild slowdown, consistent with the soft-landing scenario.

As with all economic forecasts, unexpected major shocks can change the outlook. A widening of the Gaza war in the Middle East, shocks to oil prices, or a new flare-up of the banking crisis can mean all bets are off. We must watch the data to ensure our current assessment is still valid.

All of this is good news for most of us. With a low probability of a US recession in 2024, most people can sleep easier and take a longer view of our investment and consumption decisions without worrying about avoiding a short-term major roadblock.

We should feel comfortable with our current consumption decisions, such as buying a house or a car, and our investment decisions, such as saving for retirement or enrolling in school, without having to worry about an imminent collapse. Happy, healthy, prosperous, and peaceful 2024 to everyone.