Are we in a recession yet? It's Complicated

Summary: SVB crumbles and policymakers come to the rescue, with some calling for a stop to rate hikes. Inflation has eased and the job market remains hot. So, will we have the recession that was promised?

A Hard Day’s Night

The power of social media to bring diverse groups of people together is well-known. However, last week social media, perhaps inadvertently, also became the cause of the first bank failure in U.S. history since the great financial crisis of 2008. In what will probably be studied by economists, policymakers, and stand-up comedians looking for source material, a perennially online community of tech investors and entrepreneurs managed to convince itself that Silicon Valley Bank (SVB), a 40-year-old institution, was too risky and that their deposits were not safe. Consequently, primarily because everybody was on the same slack channel and messaging group, they all rushed to withdraw their deposits, thereby causing an old-school bank run, precipitating the very same thing that they were fearing.

Although SVB was the 16th largest bank in the U.S., its demise was particularly noteworthy because, “SVB provided banking services to half of all venture-backed tech and life sciences companies in the U.S. and played an outsized role in the life of entrepreneurs and their backers, managing personal finances, investing as a limited partner in venture funds and underwriting company listings”, per a deep report by the Financial Times. Two things make this bank run unique. First, as we have alluded to above, most – if not all – of the entrepreneurs and start-up founders that bank with SVB were networked and talking to each other. That meant that most of these depositors were acting on the same information and reacting to one another. As the Financial Times article quotes a senior SVB official saying, “it turned out that one of the biggest risks to our business model was catering to a very tightly knit group of investors who exhibit herd-like mentalities.”

The second issue which supercharged the collapse of SVB, was the widespread use of mobile banking. This allowed panicked investors and depositors to liquidate their holdings with a few clicks. As Business Insider noted, “clients tried to withdraw $42 billion from the bank on Thursday — equivalent to nearly $500,000 a second over a 24-hour period — and the bank simply couldn’t meet the demand. For context, the biggest bank run of the 2007-2008 financial crash saw $16.7 billion withdrawn from Washington Mutual, a savings and loan bank, over the course of 10 days.”

Here Comes the Sun

Over the weekend, regulators sprang into action to try and contain the fallout. According to reporting by the Financial Times the “make-or-break meeting took place on Sunday afternoon, when Treasury Secretary Yellen updated Biden, Brainard and Zients, prompting the President to approve the plan to invoke emergency powers and implement the rescue. Sec. Yellen came to the gathering armed with recommendations from the Fed and FDIC”. The feeling, according to the article, was that SVB’s customers – mostly tech startups – were too important geopolitically amidst competition with China, to be allowed to fail. As the U.S. Treasury and the FDIC put SVB into liquidation, by Monday, the U.K. managed to sell SVB’s U.K. arm to HSBC. In a sign of the tech sector’s centrality in today’s economic but also geopolitical considerations, Prime Minister Rishi Sunak pitched himself as a fast-reacting “tech geek” leader. Another bank, the Signature Bank in New York, which had extensive exposure to volatile cryptocurrencies also was put into liquidation. 

These and similar jolts have resurfaced fears of a recession sometime later this year, a wholly unwelcome prospect for the Biden administration. Domestically, even a slight recession, will be disastrous for Biden’s ambitious, industrial policy-led domestic agenda, and likely imperil his bid for a re-election. Geopolitically, it would make it difficult for him to justify the continued support for Ukraine as well as create doubts amongst the Western alliance about the U.S. leadership in taking on an emboldened China. But the fear of a recession is not the same as the actual article. In January 2023, JPMorgan Chase’s (JPMC) 2023 Business Leaders Outlook Survey found almost 60% of small and mid-sized businesses expected a recession in 2023. On Monday 15th March, a “survey of more than 100 chief executives of America's biggest companies by the Business Roundtable” found that most “CEOs expected the economy to grow 1.4% this year, below the long-term trend in the U.S. but not the negative number you would expect in a recession”, according to Axios.

Hey, Jude? 

This confusion is understandable since we seem to be in uncharted economic waters. An analysis of the U.S. property market by the Economist found that, “home sales jumped in January to a ten-month high” and that since “the confidence of both homebuilders and homebuyers have improved. America’s property companies have reported more visitors to their show homes.” At the same time, consumer spending has been slowing down. “After the highest inflation in a generation, an increasing group of shoppers — including wealthy ones — are bargain hunting. Savings are dwindling. Consumer debt is piling up. The spending splurge after the height of Covid-19 is over.” Or so says an analysis by Bloomberg, which found that shoppers are moving to cheaper options and that the increase in sales growth has been due to inflation, rather than higher demand. All of this means that predicting when the next recession will hit, if at all, and how long it will last, is almost impossible. Unfortunately, however, if uncertainty lasts decision-makers will be hesitant to invest, and that is problematic.

Especially when, and by contrast, “China reported a rebound in consumer spending, industrial output and investment this year after coronavirus restrictions were dropped”, even though “unemployment rose and real estate investment continued to slump” according to another report by Bloomberg. Analysts are confident that China will meet its 5% growth targets. Elsewhere, China is systematically removing regulatory hurdles, paving the way for greater investment in technology, platforms and ecosystems. It is also taking steps to boost domestic R&D in technology and industrial manufacturing, though several companies, including Apple, have moved part of their supply chain to India. 

This comes on the heels of the U.S. announcing more restrictions on technology exports to the People’s Republic. To counter this, “Beijing has charged a new Communist party science commission, answering to Xi, with the responsibility to catch up with the west in innovation and science. This will work alongside a reinvigorated Ministry of Science and Technology,” according to an explainer from the Financial Times. Alongside changes to the structure of market regulators, these “would centralize party control over the country’s tech development efforts.” Clearly, while the U.S. mulls over further support for R&D and innovation, China is forging ahead.

 It’s All Too Much

So, what does this all have to do with a recession? The hypothesis is that if the current administration can start breaking the ground on some of its larger infrastructure promises, and if corporations can be cajoled with Productivity Linked Incentives (PLIs), then any future recession or ‘dip’ could be averted. Even if the extra spending proved inflationary in the short term, the tight labor market in the U.S. – that has thus far exceeded analysts’ expectations – would help balance a potential slowdown, by adding paychecks. This is a risky strategy that not only requires the Federal Reserve to play ball but also requires the complete absence of unforeseen shocks like runs on banks that we were taken aback by last week. Even if the likelihood of recession decreases in the near term, neither the war in Ukraine nor the longer geopolitical tensions in China are likely to diminish. That means absent other shocks, the markets, and consumers are in for a choppy ride.