US recession expected to be shorter

Oksana Patron

22 August 2023

The US recession, which is predicted to start early next year, will be shorter and much shallow which means investors will need to reposition their portfolios to be ready during the recovery, according to Principal Asset Management.

The firm’s chief global strategist, Seema Shah, noted that investors typically associated the concept of recession with drastic and prolonged asset price falls. However, the U.S. recession, according to her, “will look and feel very different from recent recessionary episodes”.

“Not only is it likely to be shorter in duration, but it will also be of a much shallower magnitude, and any risk asset declines will be similarly short and shallow,” he said.

“As a result, investors need to think beyond just preparing portfolios for recession; they need to consider how to position for recovery.”

Shah stressed that the current data painted a picture of economic strength and, as such, many investors remained skeptical of recession forecasts.

“However, current strength doesn’t invalidate impending recession. Monetary policy often works with long and variable lags, and given how quickly interest rates have been increased, policy has only been restrictive for a reasonably short period,” she noted.

“In fact, real policy rates have only recently moved into positive territory, suggesting that the pressure on economic activity is just getting underway.

“With the Fed indicating that policy rates will remain elevated for a prolonged period, a sustained monetary policy drag is expected to exacerbate already tightening credit conditions, undermining the health of the U.S. economy.”

Discussing whether the looming recession would impact financial markets severely and comparing the current situation with the run-up to the GFC, Shah said that not every recession has to be a protracted economic disaster like the Global Financial Crisis.

“The effectiveness of monetary policy and its impact on growth depends on the economy’s interest rate sensitivity,” she added.

“The 2008 recession (and, similarly, the 2001 dot-com bust) was particularly deep because of the significant debt-related excesses that had built up in specific segments of the economy, elevating the U.S. economy’s interest rate sensitivity. It took the economy several years to unwind and recover from those imbalances, resulting in multiple years of weak private sector activity, despite low interest rates.

“Today, the U.S. economy’s interest rate sensitivity is much lower. Indeed, the unique starting conditions created by the post-pandemic environment mean that today’s economy looks very different from the start of the dot-com bust and the Great Recession.”