Top analyst Ed Yardeni raises the chances of recession to 25% citing rising oil costs and a possible repeat of the Great Inflation of the Nineteen Seventies

Sep 19, 2023 | blog

Despite his friends sounding the alarm concerning the potential for a U.S. recession for over two years now, Ed Yardeni, founder and chief funding strategist at Yardeni Research, has remained steadfastly bullish. The veteran market watcher, who spent many years in varied prestigious Wall Street positions and beforehand served as a Federal Reserve Bank economist, has lengthy argued that the chances of a “hard landing” for the U.S. economic system are comparatively low as a consequence of fading inflation and a robust labor market. 

But on Monday, Yardeni revealed that the speedy rise in oil costs this summer season has raised the prospect of a Nineteen Seventies-style period of persistent inflation and a recession.

Brent crude oil costs, the worldwide benchmark, have risen 30% to over $94 per barrel since June 27 amid constant OPEC+ and Russian crude manufacturing cuts, resulting in a greater than 8% bounce in U.S. retail gasoline costs over the identical interval. While the present $3.88 nationwide common worth for a gallon of gasoline stays nicely under its $5 June 2022 peak, Yardeni argued in a Monday observe that the rising costs are “a concern.”

“If the price of oil breaches $100 per barrel and the price of gasoline rises solidly above $4.00 a gallon and both remain above those levels for a while, they could trigger a renewed wage-price spiral and higher inflationary expectations,” he warned. 

A wage-price spiral happens when staff demand wage will increase to protect their incomes during times of inflation. This finally will increase prices for companies, which then increase costs to compensate, the idea goes, resulting in spiraling inflation that may be tough to tame. 

“That scenario would be reminiscent of the 1970s,” Yardeni defined, shortly including that this “is not the scenario we consider most likely, but it is the risk to our happier outlook.”

Because of the danger of returning to excessive inflation—in addition to a number of different latest developments together with the widening Federal price range deficit, the United Auto Workers’ (UAW) strike, and a possible authorities shutdown this month—Yardeni now believes the chances of a U.S. recession by the tip of 2024 are 25%, up from his earlier prediction of 15%.

Yardeni’s forecast clashes with that of Goldman Sachs, which lowered its recession odds to the historic common of 15%, from 25%, firstly of the month. Instead of warning indicators, Goldman Sachs sees financial information that signifies low odds of a critical downturn.

“The continued positive inflation and labor market news has led us to cut our estimated 12-month U.S. recession probability further,” the funding banks’ chief economist Jan Hatzius wrote in a observe to purchasers.

Another period of weapons and butter?

In his Monday observe, Yardeni, who has additionally taught at Columbia University’s Graduate School of Business, outlined the similarities and variations between the inflationary Nineteen Seventies and the 2020s, arguing that one other period of sustained inflation is a extreme danger to the U.S. economic system—even when it’s an unlikely one. 

First and foremost, he highlighted how the federal authorities’s insurance policies are starting to reflect the “guns and butter” method of President Lyndon Johnson that laid the groundwork for the Great Inflation of the 70s and early 80s, when the patron worth index spiked as excessive as 14%. 

In the late 60’s, Johnson determined to finance the Vietnam War and his Great Society applications—together with Medicaid and the National Endowment for the Arts—by means of deficit spending, main inflation to rise, in keeping with Yardeni. Now, we’re replicating a milder model of that state of affairs after years of pandemic reduction and Ukraine War spending in addition to the passage of the CHIPS and Science Act and the Infrastructure Investment and Jobs Act that include $280 billion and $1.2 trillion worth tags, respectively.

Yardeni mentioned that fiscal coverage is unlikely to do the identical quantity of harm it did within the 70s, nonetheless. He pointed to the wholesome labor market and the energy of the U.S. greenback, which has helped preserve commodity costs from spiking as dramatically as they did in that period, and argued that the Federal Reserve has been extra aggressive elevating rates of interest to tame inflation.

Rising oil costs

Another main similarity between the Nineteen Seventies and the 2020s has been constantly rising oil costs as a consequence of wars.

“We have no doubt that the Great Inflation of the 1970s was caused by the two spikes in the price of oil during 1973/74 and again in 1979, both triggered by wars in the Middle East,” Yardeni defined, noting that oil costs jumped 213% and 166% respectively throughout these two intervals, sparking two U.S. recessions.

However, though the conflict in Ukraine additionally led to a 46% oil worth spike within the first half of 2022, the milder bounce didn’t set off a recession. And Yardeni mentioned that—until one other geopolitical disaster unfolds within the Middle East, resulting in a spike in oil costs—the almost 20% bounce in crude costs to date this 12 months “isn’t likely to cause a recession either.”

Wages and union contracts

Finally, each within the Nineteen Seventies and the 2020’s staff demanded pay will increase to match rising inflation. In the Great Inflation period, the highly effective Teamsters union, which represents truck drivers, was in a position to negotiate substantial pay raises for its members. And postal staff went on strike in 1970 and shaped a extra sturdy union of their very own, forcing the federal authorities to ultimately supply them a number of pay hikes as nicely.

The energy of the labor motion finally saved wage inflation elevated, serving to produce the sustained rise in shopper costs seen throughout that period, in keeping with Yardeni, who argues the present rise of unions might exacerbate inflation in the identical method right now.

“Today’s unions have been energized by stagnating real wages. They’ve achieved sizeable compensation gains in recent negotiations,” he mentioned, referencing the latest United Auto Workers strike and UPS union deal that included pay raises.

However, Yardeni additionally defined that union members make up a a lot smaller proportion of the labor power than they as soon as did, which ought to assist stop the dramatic wage-price spiral of the 70s. Union membership is down to six% in personal sector employment, from 16.8% in 1983.

Productivity and expertise

While the similarities between the Nineteen Seventies and right now are placing, productiveness development might save the U.S. economic system from a repeat of historical past. By the tip of the Great Inflation, within the early Nineteen Eighties, productiveness development had plunged to a document low, however Yardeni doesn’t see that taking place this time round.

“We expect to see the plethora of technological innovations boosting productivity in many more companies in many more industries than ever before. In this sense, all companies are now technology companies,” he mentioned. 

Yardeni believes annual productiveness development—which got here in at simply 1.6% in the course of the second quarter of this 12 months—will resume its upward development towards 4% later this 12 months and inflation attributable to elevated wages will “moderate,” enabling the Federal Reserve to finish its price mountain climbing marketing campaign. And until there’s an surprising oil provide disruption within the Middle East, he doesn’t anticipate the present crude worth spike to proceed. That means there’s unlikely to be a “second peak for inflation” like there was within the Nineteen Seventies that might power the Fed to lift rates of interest till they trigger a recession.

“The recent rise in the price of oil is somewhat reminiscent of what happened during the Great Inflation of the 1970s. So is the push by labor unions for higher wages to offset the rapid rise in the cost of living. Nevertheless, we don’t expect a replay of the 1970s,” Yardeni concluded.

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