00:00:00
yeah it takes sometimes uh an external
00:00:02
shock to to to cause a really major
00:00:05
recession um if there's if no s external
00:00:08
shock comes the FED can slow down the
00:00:11
economy to the uh to the level that that
00:00:14
people would call uh kind of a soft
00:00:16
Landing the problem is it's very hard to
00:00:19
engineer a soft Landing you you can you
00:00:21
can bring the play the plane down and
00:00:23
then something happens in the very last
00:00:25
bit right before you hit the runway and
00:00:27
all of a sudden it's not so soft anymore
00:00:29
wel welcome to the ripple effect the
00:00:31
podcast that takes you on a journey
00:00:33
through the minds of wart and faculty
00:00:35
I'm your host Dan Looney and in each
00:00:37
episode we'll be diving deep into the
00:00:39
inspiration behind the groundbreaking
00:00:41
research that whon professors have
00:00:43
conducted and exploring how their
00:00:45
findings resonate with the world today
00:00:48
well the question of recession is one
00:00:50
that's been in our vocabulary quite a
00:00:52
bit in recent months but whether or not
00:00:54
we see it occur is still a big question
00:00:57
will it be short and somewhat painless
00:00:59
or will it have a little bit more teeth
00:01:01
to it Nick renoff is a professor of
00:01:03
Finance here at the Wharton School and
00:01:05
joins us to look at the concept of
00:01:07
recession what we've seen historically
00:01:10
and what we could be seeing down the
00:01:11
road hey Nick great to talk to you again
00:01:13
thanks for your time hi Dan thanks for
00:01:15
having me always a pleasure always enjoy
00:01:17
talking to you thank you so the idea of
00:01:19
recession obviously right now there's
00:01:22
speculation that is out there but it
00:01:24
seems like it feels like it's a little
00:01:26
bit of a moving Target right now that we
00:01:28
don't really have
00:01:30
you know all the data that would say yes
00:01:32
or all the data that would say no at
00:01:33
this point absolutely and if you look at
00:01:36
some of the key indicators of recession
00:01:39
like the unemployment rate it's still
00:01:41
near historic lows it has only ticked up
00:01:44
a tiny bit but it's still under 4% so
00:01:47
basically the levels that we saw pre
00:01:50
pandemic so talking about recession when
00:01:53
the labor market is kind of hot the
00:01:56
unemployment low uh labor force
00:01:58
participation Rising still not quite uh
00:02:02
at prepandemic level but nearly um it
00:02:06
seems seems strange on one hand on the
00:02:08
other hand of course there is all this
00:02:09
talk of a recession why well because the
00:02:11
FED is raising rates and there is kind
00:02:14
of an old adage that says that
00:02:15
recessions uh uh don't uh don't replace
00:02:20
uh um expansions by themselves
00:02:22
expansions don't die of old age the FED
00:02:25
kills them and this is kind of what I
00:02:28
think everybody's anticipating as
00:02:30
with the increase in inflation that we
00:02:33
saw the the big wave of inflation the
00:02:35
FED trying to fight it raising rates and
00:02:38
that's what kills the expansion and
00:02:39
brings uh brings the recession about so
00:02:42
far we have not seen it the signs of uh
00:02:45
an economic slowdown are really really
00:02:49
tiny compared to the kind of the signs
00:02:52
of a kind of a healthy economy U
00:02:54
chugging along of course the markets get
00:02:57
Jitters every time that they think that
00:02:58
fed is going to tight more than has been
00:03:00
previously expected and yes there maybe
00:03:04
some uh some pockets of weakness here
00:03:07
and there um docks of uh of commercial
00:03:10
real estate collapsed are quite uh quite
00:03:14
active but so far the key uh indicators
00:03:18
of a recessionary environment that have
00:03:20
to do at least with the labor market are
00:03:22
not there historically when you think
00:03:24
about recession in air quotes uh there's
00:03:27
usually some sort of shock
00:03:30
that that really kind of sets up the
00:03:33
concept or the actual recession from
00:03:35
occurring when you look back at history
00:03:37
correct yes again yes and no based on
00:03:41
what I just said about the the fed's
00:03:43
role the FED can slow an economy down
00:03:46
and then
00:03:47
typically uh something comes along that
00:03:50
sort of breaks uh with that uh fed
00:03:53
tightening so in 2007 that was the
00:03:57
housing market that that really kind of
00:03:59
broke then then the financial system um
00:04:02
way kind of went down with it and really
00:04:06
accelerated uh accelerated the collapse
00:04:09
uh and of course with with the recent
00:04:11
the most recent recession uh the FED
00:04:14
started tightening but there were really
00:04:16
no signs of a meaningful recession until
00:04:19
all of a sudden the pandemic hit and
00:04:21
that of course had nothing to do with
00:04:23
the fed or the financial markets or
00:04:25
anything that the US consumers could
00:04:26
have done um so yeah it takes sometimes
00:04:30
uh an external shock to to to cause a
00:04:33
really major recession um if there's if
00:04:36
no such external shock comes the FED can
00:04:39
slow down the economy to the uh to the
00:04:42
level that that people would call uh a
00:04:44
soft Landing the problem is it's very
00:04:47
hard to engineer a soft Landing you you
00:04:50
can you can BR bring the play the plane
00:04:52
down and then something happens in the
00:04:53
very last bit right before you hit the
00:04:55
runway and all of a sudden it's not so
00:04:57
soft anymore I think that's kind of what
00:04:59
what happened uh in in 2008 and of
00:05:02
course you know you can't blame the FED
00:05:03
for for for 2020 but in 2008 in 2001
00:05:08
sort of a soft Lane yeah it was a
00:05:10
recession but it was a fairly short
00:05:12
fairly painless you could say recession
00:05:14
after um after the the the collapse of
00:05:17
the the do bubble of course there was
00:05:20
another external shock there 911 yeah um
00:05:24
but that but really that was uh that was
00:05:26
kind of a regular recession so how
00:05:28
important is it when when these events
00:05:30
occur a and you're looking at all of the
00:05:33
Dynamics at play it how important is it
00:05:35
to look at each one of them
00:05:37
individually and not or is it important
00:05:41
to kind of look at all of them as a
00:05:43
group to kind of understand what was in
00:05:45
play and maybe there are things that
00:05:47
correlate between different recessions
00:05:49
absolutely so uh Financial economists in
00:05:52
particular like to look at the shape of
00:05:54
the yield curve and we see that when the
00:05:56
short-term treasury yields are about of
00:05:59
long-term yields that generally is not a
00:06:03
good sign going forward for the economy
00:06:06
and in fact that is probably one
00:06:07
indicator that has consistently
00:06:10
predicted a recession in the in the next
00:06:14
you know year to two years it's not a
00:06:15
particularly precise indicator and
00:06:18
that's because the
00:06:19
long-term um treasury yields long-term
00:06:22
rates they incorporate investors
00:06:24
expectations about the future what's
00:06:27
going to happen to the economy not just
00:06:29
in the next year or two but in the in
00:06:33
the next decade or two decades um and so
00:06:36
one one reason the the long-term their
00:06:39
long-term yields might be lower than the
00:06:41
short-term yields today is that
00:06:43
investors expect both lower inflation
00:06:46
and lower growth than we've had in the
00:06:48
in the recent uh kind of post pandemic
00:06:51
uh couple of years um but another reason
00:06:54
that's often brought up is that while
00:06:55
investors expect to Fed start cutting
00:06:58
rates one in once the recession actually
00:07:02
um is on the horizon or actually is with
00:07:05
us it's a little bit self referential
00:07:08
because if we said that long rates are
00:07:09
lower than short rates because investors
00:07:12
expect the FED to cut in response to to
00:07:14
a recession that suggests that that they
00:07:17
know that the recession is coming so
00:07:19
it's not like a very useful indicator H
00:07:22
if it relies and people expecting
00:07:24
expecting a recession nevertheless it
00:07:27
has been true for the last several
00:07:29
decades that whenever the yield curve
00:07:32
quote unquote inverts again with short
00:07:34
rates higher than long rates yeah soon
00:07:38
something happens maybe because the FED
00:07:40
over Titans or something else that uh
00:07:43
that makes a recession kind of transpire
00:07:46
but we've been in that kind of a cycle
00:07:47
now for several months where the
00:07:50
shortterm bonds are are have been riding
00:07:52
quite a bit higher with yields than the
00:07:54
longer term bonds and I think is that
00:07:57
the main driver as as to why people are
00:08:00
continuing to say okay this has got to
00:08:02
be coming this is going to be around the
00:08:04
corner I think that is an important uh
00:08:07
driver maybe not the only driver but
00:08:09
certainly the fact that the FED has
00:08:12
tightened and might continue tightening
00:08:15
even though they might pause for a
00:08:17
little bit right now the consensus is
00:08:19
that they will not tighten at the next
00:08:20
meeting but but it's still you know not
00:08:23
off the table that there will be another
00:08:24
another hike if inflation uh kind of
00:08:27
rear its head again in fact as we saw
00:08:29
the latest uh latest latest inflation
00:08:31
print yesterday came in higher than
00:08:33
expected a little bit higher not a lot a
00:08:35
lot of it was oil true um some it was
00:08:38
shelter which which is in core which is
00:08:40
what the FED watches so it's possible
00:08:44
that inflation has not been conquered
00:08:46
yet uh and if that's the case fed might
00:08:49
tighten again and that'll that'll uh
00:08:51
invert the curve even further kind of
00:08:53
steepen the the inversion which means
00:08:55
people will will I think will say well
00:08:57
now they're about to break it but as you
00:09:00
said we've had this talk for for several
00:09:02
months yeah it can take a year maybe
00:09:05
even a year and a half in the past we've
00:09:07
seen these inversions uh predict a
00:09:09
recession a year to two years down the
00:09:11
road so it's not uh kind of a precise
00:09:14
science that the second you have an
00:09:15
adversion and recession is going to
00:09:17
happen it's an indicator that the FED is
00:09:21
tightening sufficiently that investors
00:09:25
don't think the you know such rates are
00:09:27
sustainable for a long time are we at a
00:09:29
point right now it seems like that that
00:09:32
November at least from a lot of the the
00:09:34
conversation out there we'll most likely
00:09:36
see a rate
00:09:38
increase but the speculation also is
00:09:41
that we've pretty much hit the top end
00:09:43
or we're very close to the top end on
00:09:46
the FED raising rates at this point is
00:09:48
is that where you think we we kind of
00:09:49
are right now um I think so unless we
00:09:53
really see inflation heat up again out
00:09:56
of not nowhere but out of the
00:09:59
combination of um well oil prices going
00:10:03
up as they as they are with the titn
00:10:06
supply constraints um The Slowdown in
00:10:09
China could further hurt Supply chains
00:10:11
and the whole supply chain worries might
00:10:14
might resurface sort of a cost uh cost
00:10:17
Channel um so it is possible it it
00:10:19
doesn't seem likely to me I I think the
00:10:22
likeliest outcome is that you know 6%
00:10:25
maybe the the top for for the fed or or
00:10:28
thereabouts and whether that happens in
00:10:30
a November meeting or or or later on
00:10:33
that's probably the the likeliest
00:10:35
outcome but you know you never know so
00:10:37
you go back to 2007 and obviously as you
00:10:40
said before there were probably some
00:10:43
actionable things that could have been
00:10:44
done at that point that well could they
00:10:48
have prevented what occurred at that
00:10:51
period of time if if changes had been
00:10:53
made and different policy had been
00:10:55
followed it's hard to tell um there is
00:10:58
that lot of debate about what happened
00:11:01
in uh 20072 2008 let alone what should
00:11:05
have been done and and and what what
00:11:07
could have been done to prevent it
00:11:09
because uh of course the housing uh
00:11:11
buildup happened over several years
00:11:14
prior to the recession uh we saw a
00:11:17
massive expand expansion of household uh
00:11:20
balance sheets uh mostly because of
00:11:23
borrowing VI mortgages Cash Out
00:11:25
refinancing was at
00:11:27
uh well historically uh high levels um
00:11:32
but obviously lots of fragility was also
00:11:34
built into the financial system uh I'm
00:11:37
not going to go through a whole whole
00:11:39
list of things that we we have debated
00:11:42
we could be here for an hour talking
00:11:43
about that exactly exactly um but uh it
00:11:47
it's not something that could have been
00:11:48
uh solved uh easily and quickly and I
00:11:51
think you know banki uh should be given
00:11:54
credit for for trying to to do the best
00:11:56
he could I think uh to contain contain
00:11:59
the crisis maybe some of the signs of
00:12:02
the of the financial crisis could have
00:12:04
been spotted sooner and some of the
00:12:06
fragility and the financial system could
00:12:07
have been uh could have been identified
00:12:09
but it's it's always easy to say that in
00:12:12
kind of in hindsight so by the way
00:12:14
speaking of mortgages and and mortgage
00:12:17
refinancing and cash out one of the
00:12:19
topics that I uh you love to research
00:12:22
the second kind of highest peak of uh
00:12:25
mortgage Cash Out refinancing happened
00:12:28
just you know a few quarters ago yeah um
00:12:31
and so we've had you know house prices
00:12:34
again at historic highs and uh and
00:12:37
households are taking advantage of that
00:12:40
even with mortgage rates rising in fact
00:12:42
you know the only people refinancing
00:12:44
mortgages in the last few months given
00:12:45
that the rates of skyrocketed are people
00:12:48
who taking out a lot of cash out of out
00:12:51
of their homes the question is if what
00:12:53
is that going to do to balance sheets of
00:12:55
these households when uh the tight thing
00:12:58
finally breaks a housing market and we
00:12:59
haven't seen a big pullback on house
00:13:01
prices it's maybe some Regional uh
00:13:04
pullbacks but not at a national level
00:13:06
and what happens then when when you're
00:13:09
talking about though man-made
00:13:11
circumstances that are kind of in and
00:13:13
around and leading up to recession does
00:13:15
that tend when you're looking back at it
00:13:18
to kind of spur kind of more of a
00:13:21
regulatory kind of viewpoint and and
00:13:23
push to to try and prevent what occurred
00:13:27
and and transl a framework so that we
00:13:30
don't ever have to deal with that that
00:13:32
scenario again absolutely but I feel
00:13:35
like what we see every time is that you
00:13:38
know the generals always fight the past
00:13:40
War The Regulators they always fight the
00:13:42
past crisis so you know we saw distress
00:13:45
test that the FED used to to test the
00:13:47
bank's ability to withstand crisis did
00:13:49
not consider possibility of a rate hike
00:13:52
they only consider the possibility of
00:13:53
recession and the rate cut so all this
00:13:56
stuff that we saw in the spraying with
00:13:57
svb and Republic the Regional Bank
00:14:00
crisis could have been perhaps avoided
00:14:03
if uh you know the the stress test mayb
00:14:06
was not subject to a stress test it was
00:14:08
too small but if if the kind of
00:14:11
regulatory operators paid attention to
00:14:13
the fact that if uh rates go up which
00:14:16
they will have to if we see inflation
00:14:18
well a lot of these banks that have
00:14:20
loaded up on Long maturity treasuries
00:14:22
will be in trouble as as they have been
00:14:25
um so I feel like there's
00:14:29
there's always kind of a past past
00:14:31
lesson to be learned yeah um but
00:14:34
whenever you learn the past lesson you
00:14:36
often forget the lessons that came
00:14:37
before that and you kind of have to take
00:14:40
a a a um a a broader view of uh what
00:14:44
kind of things that could happen and
00:14:46
there will never be a repeat of what we
00:14:48
saw in the past it'll be something
00:14:49
different so would it be fair or unfair
00:14:51
of me to ask you to get your crystal
00:14:53
ball out right now and and and look at
00:14:56
where we are right now with all of these
00:14:58
Dynam Dynamics at play and what you
00:15:01
think we may see play out over the next
00:15:04
6 to 12 months well I can always
00:15:08
speculate it would be unfair to to go
00:15:11
anywhere further than that um but I
00:15:13
think uh the again commercial real
00:15:16
estate sector I'm not an expert on but
00:15:18
from what I understand is uh is in a bit
00:15:21
of trouble and when that starts hitting
00:15:24
uh the lenders uh balance sheets uh we
00:15:27
might see might see issues there and
00:15:29
it's going to be potentially on top of
00:15:31
what we've seen so far with the um with
00:15:34
there just this treasury maturity
00:15:36
mismatch uh with liability U mismatch
00:15:40
with with with assets um but but there
00:15:43
could be other things certainly know
00:15:45
geopolitical issues don't go away you
00:15:48
know the war in in Ukraine is is uh is
00:15:51
going on and um OPAC is restricting oil
00:15:55
supplies oil prices are continuing to
00:15:57
climb um the US Shale is not able to
00:16:00
respond like it uh did in the past
00:16:03
either due to kind of ESG Capital
00:16:05
tightening or U just the fact that you
00:16:09
know labor labor market is so super
00:16:11
tight so it's hard to get Workers I I
00:16:13
know which one is kind of the dominant
00:16:15
uh the dominant constraint but so far we
00:16:17
have not seen expansion and and oil
00:16:19
drilling in the in the Shale patch
00:16:22
nearly as much as I would have expected
00:16:24
given where where prices are kind of
00:16:26
going or where they went by the way at
00:16:28
the start of the war they came down
00:16:30
quickly but now we're at the point where
00:16:32
the the Strategic petroleum Reserve is
00:16:34
at as as kind of a record low and at the
00:16:37
same time I mean it's small relative to
00:16:39
what what's the amount of oil that the
00:16:41
US economy needs anyway but um we don't
00:16:44
see this kind of a massive increase in
00:16:47
in US drilling which I would have
00:16:49
expected as a kind of response uh to the
00:16:52
oil price uh uh arises so the fact that
00:16:55
oil prices are rising may not
00:16:56
necessarily spill over into High
00:16:58
inflation so some people think it might
00:17:01
but it's not it's not good for the US
00:17:04
economy when it's restricted on the on
00:17:06
the supply side when when it's
00:17:08
restricting in its ability to produce
00:17:10
more oil I mean high oil prices are good
00:17:12
for for Texas when Texas can drill but
00:17:15
when when it doesn't have the capital to
00:17:16
do so or the workers to do so it's not
00:17:19
good news for anyone I I I'll finish on
00:17:21
this because it seems like obviously we
00:17:23
go through recessions every x amount of
00:17:26
years uh and the dynamic in many cases
00:17:30
are are different because of what
00:17:31
they've occurred so from that
00:17:34
perspective the understanding and the
00:17:35
learning from each of these different
00:17:38
recessions is just as important as the
00:17:40
last maybe for a little bit of a
00:17:42
different reason or a different impact
00:17:44
but it's still the the the learning part
00:17:46
of it is is exceptionally important
00:17:49
absolutely and certainly the fragility
00:17:51
of the financial system is now a lot
00:17:53
more to Forefront of modery policy
00:17:56
makers than it was before the financial
00:17:58
crisis yeah and and rightly so perhaps
00:18:00
and again we don't know what exactly is
00:18:03
going to break but it's quite possible
00:18:06
that something different will break in
00:18:07
financial markets this time uh compared
00:18:11
to what happened in the past so
00:18:13
certainly we should learn we should
00:18:15
learn the lessons from the past uh but
00:18:17
we shouldn't kind of forget that there's
00:18:19
lots of lessons that we've had
00:18:21
historically we should take the broad
00:18:24
view and uh also consider things that
00:18:27
perhaps are out outside of that
00:18:28
historical experience as well Nick great
00:18:30
to talk to you and thanks for your
00:18:32
Insight thank you always a pleasure you
00:18:34
got it Nick renoff of the Wharton School
00:18:37
thank you for listening to the ripple
00:18:38
effect we hope you found this episode
00:18:40
informative and engaging don't forget to
00:18:42
subscribe and leave us a review so that
00:18:44
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00:18:46
Insight from the Wharton School
