Bank of America economists made it clear on Monday that they see no signs of an imminent economic downturn.
A team led by senior US economist Aditya Barbe sought to reassure clients that while the bank expects the economy to hit a “rockier landing” this year with lower job gains and weaker GDP growth, evidence of an outright recession remains thin.
They touched on five big concerns they’ve heard from anxious clients, including the threat of a continued weakening of the labor market, consumer collapse, manufacturing woes, ripple effects on commercial real estate and an inversion of the yield curve, a closely watched recessionary indicator.
But Bavet and his team largely dismissed those concerns, assuring readers that “for now, we don’t think the broader macro data streams are signaling a recession.” Here’s why they’re so confident:
Samrule is like a suggestion?
The U.S. unemployment rate rose to 4.3% in July, triggering the “Sarm rule,” a recession indicator created by economist Claudia Sarm, and raising concerns that the labor market may be starting to crack after years of high interest rates and persistent inflation.
But while Bank of America’s economics team believes a slowdown in the labor market is the biggest risk to the economy, they don’t think the jobs report is signaling a recession yet — a position shared by Sam.
“I don’t believe we’re in a recession right now,” she told Fortune shortly after the rule was put into effect in August, adding that there’s “no need to panic … as some people seem to be.”
There is some evidence that labor market conditions have improved since then: The unemployment rate fell to 4.2% in August, and initial claims for jobless benefits, a key indicator of layoffs in the economy, fell to 219,000 in the week ended Sept. 14, the lowest level since May and down from 231,000 the previous week.
For BofA economists, the data is evidence that what we are actually seeing is a “low hiring, low firing” environment — certainly one that calls for greater caution, but is not a harbinger of doom.
“Layoffs and related jobless claims are key indicators to watch; as long as they remain low, the base case is likely to remain a soft landing,” Bave and his team wrote.
Consumers who are suffering (much)
Consumers have been under pressure for years — first the coronavirus lockdowns, then inflation and several foreign wars, and most recently rising interest rates — but Bank of America still believes they’re in a much better position than most experts would like to admit.
Bavet and his team pointed to rising credit card delinquencies and a decline in pandemic-era excess savings as two of the main data points skeptics use to show consumers are in trouble.
According to Fed data, the credit card delinquency rate reached 3.25% in the second quarter. That’s well above the 2.62% recorded in the fourth quarter of 2019, before the pandemic, but still relatively low historically. The average credit card delinquency rate since the Fed began tracking the statistic in 1991 is 3.73%.
Bank of America economists also noted that total credit card debt accounted for just 5.5% of Americans’ disposable income in the second quarter, down from 5.7% in the fourth quarter of 2019.
“While rising credit card debt and delinquencies may be a significant drag on low-income households, they are unlikely to have macroeconomic implications,” the researchers wrote.
Second, while some economists and Wall Street veterans have warned that consumers are drawing down excess savings they accumulated during the pandemic, Bave and his team noted that estimates of excess savings are “somewhat arbitrary.” So what do these statistics actually tell us about the health of consumers?
“In our view, not by much,” the economists wrote. “The wide range of estimates suggests that we should not place too much weight on the notion of a savings glut; the outlook for consumption will depend heavily on labor market developments.”
Consumers still have about $300 billion in excess savings, according to BofA’s calculations, and overall, most consumers are in a good financial position compared to previous periods, especially before the recession. Bave and his team note that Americans’ ratio of liquid assets to liabilities remains high, which is a positive sign. Before the 2008 global financial crisis, this ratio was at an all-time low, and as the economy collapsed, households were forced to sell assets to pay down debt.
“In contrast, if the labor market weakens more than expected, households would have little need to reduce their debt today,” the economists explained.
The canary in the manufacturing coal mine?
For 21 of the past 22 months, the ISM Manufacturing Index, a measure of manufacturing activity, has been below 50 and contracting.
The index was one of former Fed Chairman Alan Griespan’s favorite economic indicators, and its recent decline has some worried that a recession may be on the way, but Bavet and his team show why there’s no need to worry too much.
First, the ISM manufacturing index came in at 47.2 in August, well above the 42.5 reading that has historically signaled an economy-wide recession. Second, manufacturing is no longer the breadth of the U.S. economy, limiting its ability to forecast a broad recession. Manufacturing currently accounts for just 10% of U.S. GDP, compared with 20% in 1980 and 28.1% in 1953.
Finally, Bank of America economists don’t see any signs of overinvestment or overemployment in manufacturing, which should prevent a serious decline in manufacturing employment even if the overall economy weakens further.
“Ultimately, the signal from the ISM and the broader manufacturing backdrop do not warrant concern about increased recession risks,” they wrote. “While manufacturing is certainly weak, we would need further weakness, or broader weakness outside of manufacturing, before we start to worry too much.”
Commercial real estate, banking worries are a thing of the past
The combination of hybrid working trends and rising interest rates has proven to be a nightmare for many companies in commercial real estate (CRE), particularly the office sector: More than $94 billion of U.S. commercial real estate was deemed “distressed” in July, according to MSCI Real Assets, raising concerns that the sector could experience serious losses going forward.
Concerns are also growing about the potential knock-on effects of a disaster in the office sector on the financial system, given that some major regional banks hold large amounts of CRE debt.
But Bank of America economists note that the slow but steady return to offices in recent years and deposits at smaller banks have been growing, which should help prevent potential runs linked to commercial property losses.
“The Fed has had 18 months to address this issue, so we believe the risk of regional banks falling into crisis again is limited,” he added.
Unreliable recession indicators?
Yield curve inversions, which plot the interest rates of bonds with different maturities, have long been considered a reliable indicator of economic downturns. When short-term yields are higher than long-term yields, it’s usually a bad sign. But the yield on the two-year Treasury note has been higher than the yield on the 10-year note for nearly two and a half years without causing a recession.
While many experts are still concerned about the impact of an inverted yield curve, economists at Bank of America said they don’t see it as a major warning sign, based on historical data.
“We view the relationship between yield curve inversion and economic downturns as correlational rather than causal,” they wrote. “In our view, the severity of the yield curve inversion by historical standards reflects the fact that policy rates are very high.”
With the economy broadly resilient and the yield curve pointing to further rate cuts from the Fed, economists at Bank of America see little to fear. “Indeed, the magnitude of today’s inversion supports the likelihood of a soft landing, rather than a recession,” they wrote.
