Recession? What Recession? Why a Downturn Probably Won’t Happen.

“This virtuous circle may sound over-optimistic, but it is the normal state of a functioning capitalist economy, which is why recessions are relatively rare events,” he notes.

For the doubters, though, Kaletsk has nine other reasons recession fears are overblown. It’s not just the strength of the labor market that has Kaletsk feeling good about the future. While inflation gets a lot of attention, he doesn’t think it can puncture that virtuous cycle. Real wages may have fallen about 2% from their peak in early 2021, but aggregate compensation has risen 3%, thanks to rapid employment growth, buoying total real income. Put another way, “aggregate income and therefore aggregate consumption have grown almost as fast as they did before Covid,” Kaletsk writes.

Given today’s inflation reading, learning to live with sticky higher prices may be necessary. But if inflation continues to cool to say 5% or even lower, real wage growth will turn positive thanks to higher wages, defanging the bite of the rising cost of living.

That will only further the ability of Americans to save—not that they need to, given that excess savings are still in the $1 trillion to $2 trillion range. The wealthy may have absorbed an outsize portion of that, but Kaletsk notes that the excess these funds “represent as a percentage of normal wealth levels is actually biggest for the middle classes.”

Certainly, he notes, Americans have been able to keep spending even as prices have risen, thanks in part to those savings—they’re simply choosing to do so on experiences that were on hold during the pandemic years, rather than buying another washing machine. That accounts for the false red flag thrown up by weak manufacturing data.

Of course, all of that may be great for the economy but less so for the stock market should the Fed react to this economic strength with more hawkishness. Yet here Kaletsk is more sanguine as well. “While the Fed has raised interest rates faster than in previous cycles, this increase started from a ridiculously low level,” he writes. “If we focus on the level of interest rates instead of the rate of change, this monetary tightening is still the mildest in any cycle since the 1950s.”

Ultimately then, real long rates—long-term interest rates adjusted for inflation—can remain negative even after the Fed’s hikes push rates above the 5% mark, as is now widely expected. Nor is he much worried about yield curve inversion, noting that the popular metric has been wrong or at least very premature in the past.

Even the housing sector looks like it is starting to adjust to what is looking increasingly like the old normal. While it is weaker than many would like, the sector isn’t collapsing. “As homeowners recognize that the rock-bottom mortgage rates of 2010-2021 were an unrepeatable aberration, housing activity is likely to return to normal levels, albeit at substantially lower prices in some markets,” he writes.

That said, Kaletsk’s final point against a recession is, as he admits, more qualitative than anything else. If we were to endure a mild recession later this year before resuming growth in 2024, it would validate many of the practices we’ve grown accustomed to since the 2007-09 recession, namely printing money to fund everything from the Covid-19 response to the Ukraine-Russia war, because the cost of doing so would be so mild.

“If so, we will all have to reconsider what we thought we knew about fiscal prudence, sound monetary management and difficult political trade-offs,” he concludes.

Of course, plenty of people would be happy for that validation. But they’d probably be happy for a booming economy as well.  

Write to Teresa Rivas at teresa.rivas@barrons.com