This time last year, economists were talking about the near inevitability of a recession in 2023. In the event, the economy proved more resilient than many expected. Now, forecasts are improving for 2024 as well. If anything, the last year has reminded many forecasters that predicting recessions is a task that has eluded the best-resourced central banks for decades.
So, what can we say about the possibility of a recession hitting in 2024?
Some conditions for a recession are already fulfilled. Economists believe that most developed economies are operating beyond their capacity. This jargon refers to the fact that demand currently exceeds supply. There are, for example, shortages of some of the things economies need to grow – the most obvious being skilled labour.
Under such circumstances, central banks have been trying to bring demand and supply back into balance. One such way has sought to reduce the demand by raising interest rates. The question is whether they are able to do so with enough finesse that they do not discourage spending so heavily that they inadvertently plunge the economy into a recession.
Typically, this has proven to be a task at which policymakers fail more often than they succeed.
For them to succeed, we would need to see a more gradual realignment of demand and supply in such a way that doesn’t cause a sharp increase in unemployment. Investors call this ideal scenario a ‘soft landing’ for the economy, making it distinct from the ‘hard landing’ of a recession.
Will central banks achieve a soft landing?
With all the economic forecasting resources at their disposal, and plenty of practice, we might hope that central banks could achieve the fabled soft landing through carefully calibrated interest rate increases. The fact that inflation does seem to have peaked gives hope. But these interest rate increases do not take place in a vacuum. Often, it is the combination of the stress of higher interest rates and an external shock that tips the economy over the edge.
Examples of these shocks include the bankruptcy of Lehman Brothers and the collapse of a US housing bubble that prompted a global recession during 2008 and 2009; the collapse of the speculative bubble in technology stocks at the start of the millennium; and, in the early 1990s, the first Gulf War, which saw a sharp increase in oil prices.
So in terms of predicting whether the UK, the US or the world will enter a recession next year, we can say it is possible. In the end, however, it will likely depend upon whether the economy is subjected to some shocks which, by their nature, are unpredictable.
It’s often appropriate to paraphrase former US defence secretary Donald Rumsfeld: “There are things we know we know, there are things we know we don’t know, and there are things we don’t know that we don’t know.” This is useful structure for considering the risk in economic forecasting.
What ‘we know we know’ is that the labour market is tight and interest rates have increased substantially, which raises the risk of a recession. However, the fact that inflation is falling and that recent declines in the oil price give households more flexibility over their discretionary spending makes the soft landing scenario more likely.
The things that ‘we know we don’t know’ would include whether tensions in the Middle East could disrupt oil supply and cause a price spike of the kind that has shocked the economy into recessions in the past.
But above all, there are the things ‘we don’t know that we don’t know’. As with every year, we have to acknowledge that things could happen that will not have been predicted in this or any other outlook piece. And it is that uncertainty which has historically made the forecasting of recessions a very challenging task.
Beyond the likelihood of a potential recession, we should also consider the potential severity of one. The recession taking place as Covid struck was by far the deepest in modern times (fortunately, it was also the briefest). Prior to that, the recession accompanying the financial crisis was the deepest since the early 1900s. The bubble in real estate was symptomatic of very high levels of consumer indebtedness, which ultimately caused such a severe recession. Households then spent the following decade reducing their reliance on debt and, in aggregate, are in relatively robust financial health.
What impact could upcoming elections have?
The main concern for the coming year is not consumer indebtedness, but government indebtedness – both in terms of the risk that it could cause a shock and because of the constraints that it places governments under.
For many years, there has been anxiety over the seemingly inexorable march upwards in government debt to gross domestic product (GDP) ratios. GDP is a measure of the money that gets earned within an economy and, as such, represents an upper limit on the amount that can be used to derive government revenues (what can be taxed).
The outlook for public finances will be a further ‘known unknown’ because there are a lot of elections taking place during 2024. The two obvious ones will be a probable election in the UK (which could theoretically be held any time until January 2025) and November’s election in the US.
The UK endured a brush with fiscal mortality following the mini-budget of September 2022. Even prior to that, there was widespread acceptance by both major political parties that fiscal policy should be constrained by a robust fiscal framework with independent verification of government financial projections (from the Office for Budget Responsibility). Whilst both parties will attempt to thread the needle between appearing not to be neglectful of public services and giving hope that the historically high tax burden can be reduced, it seems unlikely that either will offer particularly bold policies to do so. Labour (which currently enjoys a commanding lead in the polls) has adopted a more centrist approach after an unsuccessful lurch to the left between 2015 and 2020. The nuance upon which the election will be fought will not be revealed until a date is set, but is likely to focus on distributional and social rather than major economic differences.
In the US, it seems likely that November’s election will be contested between president Joe Biden and former president Donald Trump. Neither seems likely to strike an austere tone on the public finances, and it is possible that the bond market could react should it appear likely that Trump will win. This is because as the Republican candidate, he has a greater chance of controlling the two houses of Congress, which set budgets, than his likely opponent. Control of the Senate, where only a third of seats are contested each election, seems very difficult for the Democrats to retain. If Congress is divided, then financial policies tend to be restrained by partisanship.
What is the overall outlook for investments?
Whilst many will look to the coming election season with dread, the bright news from an investment perspective is that US election years have historically produced quite good returns. Brighter still are the relatively high yields on bonds, which now promise better returns in future years than they had done for a decade or more. These yields reflect current high interest rates, which bring the likelihood of interest rate cuts over the coming year, either to prevent a recession or at least reduce its seriousness. These are tailwinds for the equity markets.
The value of investments, and any income from them, can fall and you may get back less than you invested. Investment values may increase or decrease as a result of currency fluctuations. Information is provided only as an example and is not a recommendation to pursue a particular strategy. Information contained in this document is believed to be reliable and accurate, but without further investigation cannot be warranted as to accuracy or completeness. Forecasts are not a reliable indicator of future performance.