Our clients and audiences generally trust our forecast for a recession in the US industrial sector beginning in the second half of 2023 and GDP weakness next year. However, some have recently expressed less confidence about our outlook for economic rise in 2025.
First, we acknowledge risks to our forecast for industrial sector and macroeconomic rise in 2025.
- The clearest risk is the potential that the Federal Reserve could delay relieving some of the interest rate pressure that it imposed via rapid hikes to the federal funds target rate in 2022 and into this year.
- We are watching the 10-year to 3-month US Treasury yield curve. If the currently inverted curve – with 3-month Treasurys commanding a higher yield than 10-year government bonds – reverts to normal status by around the end of this year or the first quarter of 2024, then we will have a key signal from the bond market that our forecast is on track.
- Our research reveals that past inversions of the yield curve of 100 basis points or greater have resolved within about one to two quarters following a corresponding peak in the federal funds target rate.
- Therefore, Fed Chair Jerome Powell’s recent comments about a couple more 25-basis-point lifts this year do not immediately threaten our forecast for economic rise in 2025.
- If the Fed is still raising rates in 2024, or keeping them high, then we may have a problem.
- Follow along with our Fed Watch series. Watch for the Fed to begin exhibiting consistently more dovish behavior. Specifically, we are watching for cuts to the federal funds target rate by the end of this year.
Second, we are seeing some green shoots that bode well for a future general rising trend:
- An upturn in the residential construction market this year would bode well for an industrial sector recovery starting by the end of next year, as the former leads the latter by close to a year.
- Some recent improvements in housing affordability – as measured by the confluence of mortgage rates, housing prices, and earnings, as well as average new home size – bode well for improvement in residential construction.
- The M2 (delated) measure of the money supply is showing some tentative signs of abating in its contraction. The indications are not yet statistically significant, but a reversal is worth watching for and would be an encouraging sign for 2025.
Third, if you knew that next year’s recession would extend into 2025, what would you be doing differently today?
- We surmise that you would, at least for now, be planning for the downturn in the same way.
- If the downside risks come to fruition and set up the recession to ultimately push past year-end 2024, we will know well before then and will be sure to inform you.