Bank of America economists made it clear on Monday they don’t see signs of an impending economic downturn.
A team led by senior U.S. economist Aditya Bhave sought to reassure clients that although the bank is now predicting a “bumpier landing” for the economy this year—with fewer job gains and weaker GDP growth—the evidence for an outright recession remains scant.
They touched on five major concerns that they’ve heard from anxious clients, including the threat of ongoing labor market weakness, cracking consumers, manufacturing woes, commercial real estate knock-on effects, and the inversion of the yield curve, which is a closely watched recession indicator.
But largely brushing off these fears, Bhave and his team assured their readers that: “For now, we think the broader macro data flow does not point to recession.” Here’s why they’re so confident.
The Sahm rule, more like a suggestion?
When the U.S. unemployment rate rose to 4.3% in July, it triggered the “Sahm rule,” a recession indicator created by the economist Claudia Sahm. That’s led to fears that after years of elevated interest rates and stubborn inflation, the labor market may be beginning to crack.
But while BoA’s economics team does believe a cooling labor market is the biggest risk to the economy, they don’t see evidence of a recession in the jobs data yet. And Sahm is in the same camp.
“I am not concerned that, at this moment, we are in a recession,” she told Fortune shortly after her rule’s triggering in August, adding that “no one should be in panic mode...though it appears some might be.”
Since then, there has been some evidence of improving labor market conditions. The unemployment rate fell to 4.2% in August, and initial jobless claims—a key measure of layoffs in the economy—sank to 219,000 for the week ending Sept. 14. That's the lowest level since May, and down from 231,000 the prior week.
For BofA’s economists, the data is evidence that what we are really seeing is a “low hire, low fire” environment. And although that does warrant greater caution, it’s not a harbinger of doom.
“Layoffs, and relatedly jobless claims, are the key indicator to watch. As long as they remain low, the base case will likely remain a soft landing,” Bhave and his team wrote.
(Not so) ailing consumers
Consumers have been under pressure for years. First, it was COVID lockdowns, then a bout of inflation and a few foreign wars, and more recently, elevated interest rates. But Bank of America still believes consumers are in a far better place than most experts are willing to acknowledge.
Bhave and his team noted that rising credit card delinquencies and fading excess savings from the pandemic-era are the two main data points that skeptics use to demonstrate consumers are in trouble.
The delinquency rate for credit cards hit 3.25% in the second quarter, according to Fed data. That’s well above the pre-pandemic 2.62% rate seen in the fourth quarter of 2019—but it’s 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’s economists also noted that total credit card debt amounted to just 5.5% of Americans’ disposable income in the second quarter, compared to 5.7% in the fourth quarter of 2019.
“Although elevated credit card debt and delinquencies could be a meaningful drag for lower-income households, they are probably not large enough to move the needle on the macro economy,” they wrote.
Second, although some economists and Wall Street veterans have warned that consumers are spending down the excess savings they built up during the pandemic, Bhave and his team noted that estimates for excess savings are “somewhat arbitrary.” So what do these statistics really say about the health of the consumer?
“In our view, not much,” the economists wrote. “The wide range of these estimates means we should not put too much stock into the concept of excess savings. The outlook for consumption will depend much more on labor market outcomes.”
By BofA’s math, consumers still have around $300 billion in excess savings, and overall, most are in a good financial position, particularly when compared to past periods that preceded recessions. Bhave and his team noted that Americans’ ratio of liquid assets to liabilities remains elevated, which is a positive sign. Prior to the Global Financial Crisis of 2008, this ratio was at an all-time low, which forced households to sell assets to pay their debts when the economy cracked.
“By contrast, households would have little need to deleverage today if the labor market were to deteriorate more than we expect,” the economists explained.
A canary in the manufacturing coal mine?
For 21 of the last 22 months, the ISM manufacturing index, which measures activity in that sector, has been in contraction territory with readings below 50.
This index was one of former Fed Chair Alan Greespan’s favorite economic indicators, and its recent slump has some concerned that a recession could be on the way. But Bhave and his team offered reasons not to be too concerned.
First, the ISM manufacturing index came in at 47.2 in August, well above the 42.5 level that has signaled an economy-wide recession historically. Second, the manufacturing sector is no longer a dominant force in the U.S. economy, meaning its ability to forecast widespread contractions is now limited. The manufacturing sector makes up just 10% of U.S. GDP today, compared to 20% in 1980, and 28.1% in 1953.
Finally, BofA’s economists don’t see signs of overinvestment or over-hiring in manufacturing, which should prevent a serious dip in employment in the sector if the wider economy weakens further.
“The bottom line is that the signal from ISM and the broader manufacturing sector backdrop does not have us worried about an increased risk of recession,” they wrote. “Yes, the sector is soft, but it will take further weakness or broader weakness beyond manufacturing before we get too concerned.”
Commercial real estate, banking scares are in the rearview
The combination of the hybrid work trend and rising interest rates has proven to be a nightmare for many in commercial real estate (CRE), particularly in the office sector. In July, more than $94 billion of U.S. commercial real estate was considered “distressed,” according to MSCI Real Assets. That’s led to concerns about the potential for serious losses in the sector moving forward.
With some key regional banks holding large amounts of CRE debt, fears about potential knock-on effects to the financial system from an office sector disaster have spread as well.
But BofA’s economists noted that there’s been a slow, but steady return to the office in recent years, and small banks’ deposits are on the rise, which should help prevent any potential CRE loss-related bank runs.
“With the Fed having now had 18 months to get its arms around the issue, we think the risks of another regional bank scare are limited,” they added.
An unreliable recession indicator?
An inversion of the yield curve, which plots interest rates on bonds of different maturities, has long been seen as a reliable recession indicator. When short-term yields are higher than long-term yields, it’s typically a bad sign. But the 2-year Treasury yield has been above the 10-year Treasury's for almost two and a half years without triggering a recession.
Although many experts remain concerned about the implications of the yield curve inversion, BofA’s economists said they don’t see it as a major warning sign when looking at the historical data.
“We view the relationship between yield curve inversion and recessions as mostly correlation rather than causality,” they wrote. “Our take is that the deep inversion of the curve by historical standards largely reflects the fact that policy rates are very elevated.”
With the economy mostly remaining resilient, and the yield curve implying more Fed rate cuts are coming, BofA’s economists don’t see much to fear. “In fact, the degree of inversion today endorses a high probability of a soft landing, rather than a recession,” they wrote.
