A prominent question of recent months has been: will there be a recession? There are only two forecasters who truly understand the probabilities of this – the sovereign bond market and the corporate bond market – and, unfortunately, they disagree. However, on our side, we lean more toward the idea that a global recession this year is unlikely. Here, we aim to explore our reasoning, and those of the bond markets.

‘Recession’, like ‘inflation’, is a very well-known but extremely fuzzy concept in economics. In brief, common practice dictates that there is only a recession when the National Bureau of Economic Research (NBER) says so, usually citing ‘widespread weakness’ in the economy.

However, it is helpful to note that recessions hardly ever occur in modern developed economies given the breadth of their economic activity, and that if they do occur, they are most often triggered by an external shock (such as a pandemic) or a systemic crisis (such as a meltdown of the financial system).

How is a recession defined?

I began my career in the finance industry in 1995, just in time to witness my first recession in business. In 1994, the US Federal Reserve (Fed) surprised markets by raising interest rates. As a result, the gold rush in equities was choked off, and emerging market economies, such as Mexico’s, began to unravel. The so-called ‘tequila crisis’ in Mexico spread to Asia and Russia, where similar crises occurred later that decade. “But Christian, there was no recession in the US in 1995!”, you might protest. And you would be right, of course.

So what happened? The NBER did, in fact, announce a recession a couple of quarters following the Fed’s rate decision, but they later revised their judgement, explaining that the composition of the gross domestic product (GDP) output numbers had been adjusted in the meantime and thus the 1995 slowdown did not qualify as a recession. In their view, the case was closed.

Well, my humble learning as a young economist was simply: a recession is only when the NBER says so. Before that, one of the many definitions we had to memorise as students was that a recession is two consecutive quarters of negative growth. Rubbish. Declaring a recession is a judgment call by a group of economists who are entitled to do so.

What kind of economies avoid recessions?

Modern developed economies hardly experience any recessions anymore. Take the Australian economy, for instance: between the early 1990s and the Covid-19-related recession in 2020, the Australian economy did not post a single recession. When I was made aware of this fact, I must admit that I was quite surprised. From afar, the Australian economy had all the ingredients of a highly cyclical one in my way of thinking.

It was commodity-heavy, and commodity cycles are of the worst kind in terms of amplitude, going from boom to depression; it was highly open to business partners like China, which was the shop floor of the world economy in the second half of the period in question and susceptible to global slowdowns; and it was not too domestically oriented given its rather small population in comparison to the size of the country.

But my intuitions were trumped by the economic reality – the Australian economy was able to balance the various cycles and thrive over three decades. That said, although the economy down under is exemplary, it is certainly no exception: Canada has made it 15 years without a recession since 2000, and so has Switzerland.

Is there such a thing as a healthy recession?

In order to judge whether an economic slowdown deserves the ‘recession’ label or not, the NBER looks for widespread weakness across sectors and industries. But why does it matter at all? You could argue that, if the economy is so well balanced and recessions are so rare, it should not matter whether it is a recession or not. Or, alternatively, I sometimes get asked the question whether a recession is not a healthy thing now and then, e.g. to shake out the slack in the economy.

I maintain that recessions in modern developed economies are more like pneumonia than a cold in the human body. In economics, I would argue that policymakers have to do their utmost to fight recessionary tendencies whenever they appear. If you follow the argument that a modern developed economy is a balanced system, then a widespread weakness should ring an alarm bell.

Will there be a recession in 2023? The jury is still out

As we said earlier, there are only two forecasters who truly understand the probabilities of a recession – the sovereign bond market and the corporate bond market – and they don’t agree.

The trouble with this conclusion is that the other best forecaster, the corporate bond market, does not agree.

Of course, the contradictory messages leave economists, strategists, and investors in limbo. We hear a lot of second-guessing these days along the lines of “this time is different”. However, these are the four most dangerous words in economic analysis, so we will not engage in second-guessing. Instead, we lean towards the view of the corporate bond market for now, i.e. that a recession is quite unlikely.

Why do we think a recession is unlikely?

Our first reason for supporting this view is that, thus far, we do not see an external shock or a systemic crisis like the ones discussed above that could threaten the economic system.

The second reason is that economic dynamics are very diverse across the world, which means that globally synchronised recessions are unlikely. In other words, economic regions around the globe are growing at very different speeds.

The final and remaining risk, though, is policymakers. If they continue to steer geopolitical games with protectionist moves, or if they continue to use monetary policy to fight inflationary pressure while only looking in the rear-view mirror, the risk of an accident occurring will increase going forward. And the outcome then could be much worse: a full-blown recession. Let us hope that reason returns before this happens, as has often been the case after serious stress events in the past.