The headlines for the last two years have gone back and forth over the risk of a U.S. recession. At first, some economists were convinced we’d have a recession, then they weren’t, then they were, and then they weren’t…again.
So, what’s the forecast now? According to Deutsche Bank, the likelihood of a U.S. recession is 100%.
That is a staggeringly confident—and gloomy—prediction. How can Deutsche Bank be so certain? Will a recession really happen soon, and if yes, what should real estate investors be prepared for?
Spoiler alert: As we’ll see, the likelihood of the recession may be less important than its predicted severity.
Why is Deutsche Bank Predicting a Recession?
Deutsche Bank has been researching recessions for a while, and it uses four key economic indicators to determine the likelihood of a looming recession:
- Rising inflation
- Rising interest rates
- An inverted yield curve
- Soaring oil prices
Of these four, the first three markers are especially concerning. The economists at Deutsche Bank studied 34 past U.S. recessions dating back to 1854. They found that once these macroeconomic factors hit a specific threshold, it correlated with a very high probability of a subsequent recession. As you can imagine, a combination of more than one of these factors makes a recession even more likely overall. And although it’s impossible to predict a recession with 100% accuracy based on any one of the markers individually, it’s when they stack up that economists take note.
Here’s a look at each factor.
Rising inflation
This is by far the most concerning of the four recession signs. Deutsche Bank finds that a 3% rise in inflation over a two-year period triggered a recession in 77% of cases. Although U.S. inflation has dramatically fallen over the past year, from a very worrying 9% to 3.7%, the conditions for a recession have been well met, according to historical data.
Rising inflation doesn’t always trigger recessions worldwide, with the U.K. and European economies apparently more resilient to inflation spikes. The U.S. economy, however, appears to be uniquely “sensitive” to this economic factor, according to Deutsche Bank research leader Jim Reed.
Inflation affects consumer spending and has a knock-on effect on real estate markets. However, so far, high inflation rates have not affected U.S. consumer spending all that much. Still, if inflation rates stay at the level they are now, the government will most likely bring in measures to curb inflation, particularly by raising interest rates even further, which in itself could contribute to the U.S. entering a recession.
Rapidly rising interest rates
In their own right, rapidly rising interest rates correspond to subsequent recessions in 69% of cases studied by Deutsche Bank. It’s still a pretty high figure, but not as high as inflation. The link between these two factors appears to be the most problematic for the U.S. economy. Why?
Partially, high interest rates raised with the specific goal of preventing a recession, as in slowing down an overheated economy, can act as a self-fulfilling prophecy. Lenders tend to react to rapidly rising interest rates with caution. The result is sometimes an inverted yield curve, which is not good news for the economy.
An inverted yield curve
An inverted yield curve is when interest rates on short-term loans are higher than those on longer-term loans of the same risk profile. This macroeconomic factor is a telltale sign of lenders trying to mitigate future damage from a recession, which will always have low interest rates.
An inverted yield curve correlates with recessions in 74% of the cases studied by Deutsche Bank. Notably, this number rises to 79.9% if only recessions since 1953 are taken into account. The rise of the importance of long-term bonds (e.g., mortgages) to the economy is almost certainly a factor here.
Soaring oil prices
Finally, rapidly rising oil prices have been linked to recessions by the Deutsche Bank research team, albeit with less certainty than the other factors. The U.S. economy is somewhat resilient to oil price shocks, with oil price surges leading to recessions in only 45.9% of cases.
Will a Recession Really Happen?
This is the million-dollar question. While the “100% likelihood” of a recession prediction makes for attention-grabbing headlines, no economist can truly predict a recession with 100% accuracy. In fact, economists are notorious for getting their recession predictions wrong, as I mentioned at the beginning of the article.
Deutsche Bank itself got it wrong back in 2016, predicting a recession that never materialized. It is worth noting that it used different indicators for its metrics back then, notably capital expenditure growth and the Fed’s Labor Market Conditions Index. The LMCI, for one, has not proven to be a very reliable metric, with previous research finding that “it is not uncommon for different indicators to send conflicting signals about labor market conditions.”
Arguably, the way the bank conducts its research into recession probability is more reliable now. More data over a much longer stretch of time and more reliable key indicators have improved the quality of the research.
So, is it different this time, and should investors be bracing for a looming recession? Possibly. What is different this time around is the fact that at least two of the four recession triggers have been artificially engineered. As David Folkerts-Landau, Deutsche Bank chief economist, explained:
‘’The U.S. is heading for its first genuine policy-led boom-bust cycle in at least four decades. The inflation we see was induced largely by expansive fiscal and monetary policy, and the aggressive rate hikes needed to tame that have now materialized. Avoiding a hard landing would be historically unprecedented.’’
Even so, reading past the scary headlines puts the forecast into perspective. The recession, which presumably will begin during Q4 of this year, will be ‘’moderate’’ at most, with a predicted contraction of the economy by 0.4% in 2024. The result would be an inevitable stagnation in consumer spending and rising unemployment, but again, the predicted numbers are far from catastrophic (a 4.5% unemployment rate in 2024 versus the 3.7% current rate).
In fact, Deutsche Bank appears to have somewhat revised its prediction in light of these numbers, saying on Monday that it now sees the possibility of a ‘’softer landing’’ than its original ‘’boom-and-bust’’ estimate. That’s in light of an economy that is proving to be more resilient in the face of the key recession indicators.
Should Real Estate Investors Be Worried?
Quite simply, no. Even if Deutsche Bank’s prediction comes true, the trajectory it’s predicting is one of a modest decline over a period of many months, with a 2024 start. The “boom-and-bust” warning is lacking the signs of a true bust, which would be truly detrimental to the real estate market.
Despite the gradual, consistent slowing of the real estate market over the past year, overall market conditions remain fine for investors. Low levels of new construction and sticky housing demand allowing for continued home price growth (albeit modest) even in the face of rising interest rates are the factors that will prevent a market crash—not to mention a significantly better-regulated mortgage market, which has resulted in low rates of foreclosures.
As always, be aware of any changes within your local market. If we do enter a recession and unemployment hits your area harder than the national average, for example, you may need to react sooner and more proactively than if you are in an area that is more economically resilient.
Above all, take all predictions with a pinch of salt and ground any investment decisions in actual market conditions, not prophecies of doom.
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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.
