Are we heading for a recession? Latest CPI read - slowdown on deflation

The latest US CPI (YoY) read came out today. The consensus estimate was 6.2 while the read came in at 6.4. Last month’s read was 6.5. The market is reading this as mixed news. On one hand inflation is cooling, while on the other hand that rate of cooling has slowed down. While the saying goes that “one month is not a trend”, the latest news is not bad in that trend hasn’t changed, but it’s bad in that it may be an indication that inflation may stick around much longer.

Cooling, but somewhat sticky inflation means higher interest rates for longer. That in itself should not be an issue - humanity has survived higher interest rates before. I’m not saying it’s not going to be painful. But the issue is two-folds: one is the fact that we have come from a world of very low interest rates that have been with us for more than a decade - it means that the shift, which typically plays out over several years will be a seismic one - scale being dependent on how wide that gap is between the lower interest rates of the bygone days and the higher one that everybody needs to shift to. Second is that, if inflation remains sticky, it will mean that the central banks will have to take rates that much higher. From a historical point-of-view, a few episodes notwithstanding, interest rates have always been able to tame inflation only by pushing it down - pull function doesn’t seem to exist. By pushing it down, I mean interest rates being able to push inflation down in a persistent way only when central bank interest rates have been higher than inflation rate. So, point number 2 could extend the impact of point no. 1.

So, what does it all mean to the layman, to the business manager, to the entrepreneur?

The impact would realize in the form of forward planning - hiring decisions, business expansion decisions, order sizing, spending, and borrowing etc. At this point, what comes to everyone’s mind is the “R” word - recession. Will there one? How bad will it be? Will there be a “soft-landing” instead? Just in case anyone is guessing, “soft-landing” refers to a state in which the central bank has managed to get interest rate to a higher plateau without causing a recession. If one airline analogy was not enough, some are putting in a new scenario, appropriately termed in the context as a “go-around” (a scenario in which no recession is caused by interest rates are brought back down due to deteriorating economic conditions and then once again an attempt is made at a soft landing starting with raising rates). Back to the question - are we heading towards a recession? Short answer: nobody knows. A lot of conventional indicators are flashing “red” currently - indicating a recession - from yield-curve inversions to leading indicators etc. But there are some others that are not giving up - most of these in the periphery of the consumer. This is in part a hangover effect of the stimulus that we received during covid crisis - the covid high still flowing through the veins of the economy – causing inflation fever, but again also not letting the patient die. This is a very unconventional scenario - so we don’t have historical data to refer to some of the phenomenon that we’re noticing today. In the parlance of the flights and airlines analogy, this is akin to having foam laid out on the runway. Nobody has landed on a foam before, and we don’t know how long the foam will be able to support the weight of the plane and its downward force. Did I answer your question?

Okay, once again, are we heading to a recession?

Let me start with the disclaimer that I’m no expert. But I do have a viewpoint. And at a point where even experts appear very confused, I guess I might share it as well. So, here it goes - if we are able to get inflation down, without meaningful upturn in unemployment, if we’re able to restore the supply chains to the point of supply/demand balance, and if we can find resolution/clarity on major geopolitical issues, we may be able to avoid a recession. Looking back at that statement, I just see a few too many “ifs” for comfort. So, the world needs to do a lot of things right to avoid one – it is possible, but probability appears to be stacking somewhat against it at this point. I want to add something to the first point - there are some predictions of the soft-landing scenario where they believe we will achieve soft-landing by getting inflation under control by getting unemployment somewhat higher without causing a recession. But looking back at data, I haven’t found a single occurrence in history where a meaningful uptick in unemployment has not been accompanied by a recession. In fact, a meaningful unemployment has in many cases appeared to be leading us into a recession. So, I would say, care for what you wish for! And keep your eyes open for the next couple of CPI reads and central bank interest rate decisions.