Ed Yardeni, a major Wall Street leader and president of investment consulting firm Yardeni Research, recently wrote that economists' predictions of the US recession are generally wrong. The following is his opinion.

Over the past two years, most economists have predicted a recession in the US. In fact, it was the most widely anticipated recession that did not happen.

This became more apparent at the beginning of this year. However, although most people have abandoned their pessimistic recession predictions, many analysts predict that if US inflation continues to ease, the Federal Reserve will have to cut interest rates several times to avoid a recession. This prediction also seems wrong, and now more and more economists are discussing the prospect of “staying high for a longer period of time.”

It is logical to expect a recession in the US economy over the past two years. After all, the Federal Reserve raised the federal funds rate by 5.25% from March 2022 to July 2023. Clearly, monetary policy tightening of this magnitude appears to trigger some rupture in the financial system, leading to a credit crunch, and thus to a recession. Once this happens, the Federal Reserve will be forced to cut interest rates quickly. This has been the mode of operation for most monetary policy cycles since the 1960s.

There are many reliable indicators that a recession is imminent. In the summer of 2022, the yield curves of US 2-year and 10-year Treasury bonds were inverted. Short-term yields on US Treasury bonds exceeded long-term yields, as was the case before the previous recession. Leading economic indicators reached a record high in December 2021 and continued to decline thereafter until April 2022, indicating a potential recession in the US economy. The actual annual growth rate of M2 (broad money supply) turned negative in May 2022 and continued until March of this year.

Yardeni pointed out that economists' predictions were grossly wrong, and the above indicators were misleading.

Past recessions have mostly been caused by credit crunch, soaring oil prices, or the bursting of speculative bubbles. This time, as in the past, the inversion of the yield curve accurately predicted the arrival of a financial crisis. The banking crisis did occur in March 2023, but it did not last long and did not trigger a credit crunch, as the Federal Reserve quickly provided emergency liquidity support to the banking sector. After the Russian-Ukrainian conflict broke out, oil prices soared, but sufficient global supply and weak global economic growth caused a rapid decline. Oil prices rose again in March as clashes between Israel and Hamas showed signs of a wider regional conflict, but then fell back down.

The US economy is also more resilient than economists expected, mainly because consumer spending continues to rise. Many households benefit from higher interest rates on bank deposits and money market funds. Many also refunded their home mortgages in 2020 and 2021 at record low interest rates.

Most importantly, baby boomers are beginning to retire, and they have a record net worth of $76 trillion. They are spending more on restaurants, cruises, travel, and healthcare. All of these service industries are expanding their workforce, thereby increasing actual revenue and further driving more consumption. The commodity sector of the economy has been growing and declining since the buying boom in March 2021, yet the level of commodity spending adjusted for inflation remains at a historically high level.

Moreover, the tight monetary policy was offset by an extremely stimulating fiscal policy. The US federal deficit is widening due to large infrastructure spending and government incentives to encourage businesses to relocate. The federal government's net interest expenses have surged, and personal interest income has risen to a record high as a result.

The company's profits and cash flow have also been maintained very well. Higher interest rates have not deterred capital expenditure, as many companies raised capital and refunded in 2020 and 2021 when borrowing costs were low. Large spending on technical hardware, software, and research and development also contributed to an increase in capital expenditure. As a result, productivity growth rebounded last year and should continue to be strong.

So what about leading economic indicators? The reason it didn't work well is because it heavily favors the relatively weak commodity economy and does not give sufficient weight to the service sector, which has always been strong.

Economists need to remember that history doesn't always repeat itself. They should rely less on leading indicators and other simple models, and more on common sense.

edit/emily