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