Liam Dann: Recession risk is rising… why it might be good

OPINION:

We could be heading into a recession.

We should be prepared for this. I also think it might not be such a bad thing for the economy, if it’s short and to the point…and we don’t
panic.

I was surprised to find that I think so, given that I generally try to remain optimistic about the economic outlook.

But, along with my colleague Anne Gibson, I did a live Q&A session on the Herald website last week.

These sessions are quick and require immediate answers to some pretty important questions about the economy. There is therefore a tendency to rely on one’s intuition about things.

“My instinct is that we’re going to see a recession or approach one next year,” I told Herald reader Danny C.

“Central banks now have the bit between their teeth and are chasing inflation. Rates are rising very rapidly from a historical perspective, even if they come off a low base.”

Danny C wanted to know if now was the right time to sell a house. For the record, I have adhered to the opinion approved by the Autorité des marchés financiers on this subject.

Nothing I say should be taken as personal financial advice. You should be guided by your own financial situation as much as by macro-economic circumstances.

But overall, it looks like we’re going to see a slowdown over the coming year.

House prices have already fallen by 4.1% and economists predict that they will continue to fall – up to 10%.

The local stock market – which can be a pretty good indicator for these things – is down about 12%.

Financial industry pundits like to point fingers at bond markets. Specifically, if the US Treasury yield curve “inverts,” this is considered one of the strongest predictors of recession there is.

Normally, if yields are plotted over time on a graph, they should curve to the right, indicating a higher investment return for bonds held longer term.

If you think of interest on term deposits, for example, banks offer a higher rate of return the longer you’re willing to lock yourself into a fixed term.

An inversion means that short-term rates (like those on two-year Treasury bills) are higher than long-term rates.

In other words, bond investors are paid more for holding US government debt in the short term than for holding it in the longer term.

This means that the market has become very gloomy about the longer term economic outlook.

This has happened in the bond markets this year.

Really good that there is a simpler indicator of recession risk than this.

When interest rates rise, recessions often follow.

And the faster central banks raise rates, the more likely a recession is.

In New Zealand, we are increasing rates very quickly now. In fact, if the OCR rises as high as market expectations – to 3.75 or 4% – it will be one of the fastest rate hike cycles in our history.

It’s not hard to see how this could shock the economy into recession.

The cost of servicing debt is rising so rapidly that companies and risk-taking investors (think real estate developers) may find themselves struggling with cash.

The Reserve Bank clearly intends to chase inflation now. There is nothing in its mandate to stop it, as long as unemployment remains below historical definitions of full employment – at around 5%.

New data this week is expected to show another record low at 3% for the first quarter.

This means that the RBNZ has more leeway than usual to compress the demand side of the economy without causing undue economic hardship.

The reality is that for most people, as long as you don’t lose your job, a recession isn’t such a bad time.

The cost of living is falling. With less demand in the economy, getting things done becomes easier.

This is what the Reserve Bank hopes to see.

Obviously, everyone, myself included, hopes that we can bring inflation back into its box (between 1 and 3%) without needing a hard landing for the economy.

Nobody wants a recession. Stalling economic growth is risky because if business and consumer confidence gets too bleak, we can get stuck there.

There are things that could still help us facilitate a soft landing.

The world may finally have good news about major historical events like war and the pandemic. Supply chain issues could resolve faster than expected.

That would be nice and it would mean that interest rates wouldn’t need to rise that far.

Tourism could return faster than expected, giving the economy a welcome boost.

I’m certainly not gloomy enough to worry that we’re going back to the recession cycles of the 1970s and 1980s.

Even if you think they’ve been slow to act, central banks are moving much more decisively to target inflation than they did back then.

We have this low unemployment base.

The New Zealand government’s finances are in much better shape and we are still seeing high prices for our exports – which was not the case in the 1970s.

Our economy is much more open and sensitive to economic signals. It can quickly rebalance itself when given a boost.

But more and more my gut tells me that a dip into recession is the most likely outcome of the battle to defeat inflation.

It might even be good for us.