In this podcast, Jamie Newton, head of Global Fixed Income Research and deputy head of Sustainability at Allspring, and Rick Hartley, senior vice president and client advisor on the Insurance Solutions team, discuss reasons the U.S. economy has remained resilient to date, the signs pointing to a possible recession on the horizon, and strategies investors can use to prepare for it.
Jamie Newton: I think the writing’s on the wall, but a recession is not guaranteed. And so, investors should bias their fixed income portfolios towards quality against a weakening backdrop.
Rick Hartley: That’s Jamie Newton, head of Global Fixed Income Research and deputy head of Sustainability here at Allspring. I’m Rick Hartley, senior vice president and client advisor for our Insurance Solutions team, and you’re listening to On The Trading Desk®. Today, we’re discussing why U.S. economic growth has remained resilient to date in 2023 and, better yet, the reasons why we may see a recession later this year or early in 2024 and, Importantly, how investors can best prepare for the outcome. Thanks for being here, Jamie.
Jamie: Hey, Rick. Thanks for having me here.
Rick: One of the things that has puzzled investors is why the onset of the recession in the U.S. has been so slow incoming. You address this in your recent paper titled, No recession yet, but risks are rising. Are you prepared?, which can be found on the Insights section of allspringglobal.com. You laid out some reasons that the U.S. economy has shown surprising resilience. Can you touch on these here?
Jamie: In the paper, we noted a couple of different things. First, if we just think back what’s happened over the last decade plus, a lot of companies and individuals have been able to take on low-cost debt. We had low rates in the market, the economy was buzzing along, spread premiums were low, and the markets grew. And both companies and individuals took on a lower cost debt. And that was further enhanced during the pandemic, if you think about the very low rates we had during that point in time. However, since early 2022, we’ve seen rates rise. The Fed (Federal Reserve) is moving and that’s going to create an interest burden to service that debt that we just haven’t seen for some time. Additionally, physical stimulus from COVID packages, student loan payment deferrals, and the hybrid work arrangements that we’ve all benefited from are slowly going away. And that’s going to start to weigh on consumers at some point. Certainly, to date, we haven’t seen that, but it’s going to happen.
Rick: It is amazing how important fiscal and monetary stimulus has been for sustaining growth in this post pandemic period. But in your paper, you laid out several reasons why we may not escape recession altogether. Can you highlight some of those?
Jamie: Absolutely. First, excess saving rates have been steadily declining since the third quarter of 2021. Again, it goes back to a lot of those fiscal packages that were received because of COVID. But we started to ebb lower and turn negative for the first time in the first quarter this year. Second, consumer focus lending, such as credit cards and autos, are seeing rising delinquency rates and usage rates, which we think is only a telltale sign that consumers are starting to see some pressure. Additionally, student loan payment deferrals are going to end this fall. After the Supreme Court ruling earlier this year, payments are going to be required again beginning in October and that’s just going to weigh on the consumer, in general. As you roll those loans, you’re doing so at higher rates and you’re starting to feel the pinch of that because of that increased interest cost. Third, debt that doesn’t get paid down has to be rolled or refinanced, again, at those higher rates. And about 30% of the entire corporate market matures in the next three years. So, the problem is not going away unless something happens and there’s a surprise and we see rates suddenly go back to zero. But we don’t foresee that. And so, higher rates for longer is going to weigh on both corporations and individuals because of that additional interest cost. Fourth, we’ve had a strong jobs market and it’s very supportive. But that strong jobs market with PCE (personal consumption expenditures) readings remaining higher than the Fed would like implies that future rate cuts might not be coming as quickly as what the market had been assuming earlier this year. The Fed doesn’t want to make a mistake of easing monetary policy too soon in this cycle. And as we’ve seen recent data, the numbers are still strong. And so, I don’t see a reduction in rates anytime soon. Next, banks have tightened their lending standards. If we think of what happened earlier this year with Silicon Valley Bank and some of the other situations, banks have really tightened their lending standards and reduced risk on their loan books. That’s tightening availability. The other part of that is commercial real estate. Commercial real estate borrowers are very much in the news. And they’re feeling the double whammy of tighter lending standards, higher rates, and, at the same time, seeing less demand from corporations as they deal with this hybrid work-from-home environment that’s led to lower rents, which has hit their ability to pay their own debts. So, we’re going to see this continue to manifest over time, but there will be some opportunities in the space we’ll want to take advantage of. And finally, the U.S. and Global Purchasing Managers Index readings, which measure the strength of the manufacturing sector, have been weakening since mid-2021, and have actually fallen into contractionary territory. So, a manufacturing recession may foretell a broader recession. Something we have to think about.
Rick: OK. You laid out a lot of variables that are conspiring for an economic slowdown in the near to intermediate horizon.
Jamie: Yeah, I think the writing’s on the wall. It’s certainly lasted longer than what we expected. But I do think that we’re going to see pressure mount in the fourth quarter and into the first couple of quarters of next year. It just takes time to play itself out in the GDP (gross domestic product) numbers.
Rick: Yeah.
Jamie: Well, I laid out a lot of risks. I do want to emphasize that a recession is not guaranteed. We do expect there to be a slowdown. But again, the Fed has been very good at maneuvering so far. And they may be able to do something similar. So, we think a slowdown is coming, but it’s certainly not a guaranteed situation.
Rick: So, with that, with those variables that may impact the economy, what can investors do to prepare for a recession or, at the least, a further slowdown in growth?
Jamie: I think there are several things that an investor can do. First, I caution investors not to get caught in the cash trap. Obviously, short-term yields are very attractive right now. But if we do get into a slowdown and the Fed reacts, you will see a move lower in the front end of the yield curve. So, right now, I would say start to think about extending duration into the 2-, 3-, 5-year part of the curve and opportunistically longer as you see fit because there’s an opportunity now to grab really good yield further out the curve and not just be stuck on the very, very front end. Second, the bond markets are very broad and dynamic and it’s likely that the effects of the recession will be felt unevenly across fixed income sectors. Because of that reason, investors should stay diversified and look for ways to actively select the best sectors and issuers while sustaining their strategic allocations to the debt markets. Finally, investors should bias their fixed income portfolios toward quality against this weakening backdrop. The focus on fundamentals that define resiliency, including leverage, interest coverage, and margins, for example, should guide investors toward the best opportunities in this environment.
Rick: Well put. On behalf of our listeners, thanks for taking us through the topic.
Jamie: Yeah, my pleasure, Rick. Thanks for having me.
Rick: And for our listeners, be sure to check out Jamie’s paper on this topic at allspringglobal.com. Until next time, this is On The Trading Desk®. Thank you for joining us.
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