One Recession Indicator Isn’t Flashing Warning Signs Yet—Here’s Why That May Change

Topline

As the Federal Reserve gears up for another mega-sized interest rate hike to help cool the economy, one reliable indicator from the Fed is pointing to ongoing resilience among corporate profits, suggesting there’s still room for the economy to unwind further before it falls into a recession.

Key Facts

From a housing market collapse to a sharp slowdown in manufacturing, economic indicators have been flashing warning signs this year, but businesses have been largely resilient, Schroders chief economist Keith Wade wrote in a Tuesday research note, citing as evidence that the Fed’s flow of funds data shows corporations still operating at a surplus.

Every recession since at least the 1960s has coincided with corporations running on a deficit, but Wade explains high inflation, the culprit behind the Fed’s growing interest rate hikes, has helped corporations bolster profits despite the broader slowdown, with many simply passing on higher costs to consumers by raising prices.

As a result, most large companies—save for high-flying technology firms that are typically more vulnerable to a slowdown—have yet to see the sort of pressure that would usually trigger deficits, even though households have started to feel the crunch.

This conclusion has been reinforced by the third-quarter earnings season seeing “some downgrades, but no great calamities,” Wade notes, but he cautions the ongoing strength is unsustainable because the Fed likely won’t pause its rate hikes, which tend to drive spending down, until corporations have lost enough demand to bring down inflation.

An interest increase today can take up to two years to have its full effect on the economy, but Wade notes the current corporate strength only bolsters the Fed’s case for another 75-basis-point hike on Wednesday—and also forces it to send “a strong signal” to corporations that it’s determined to beat inflation, even if it means a recession.

What To Watch For

Fed officials are slated to announce how big the next interest rate hike will be at the conclusion of their upcoming two-day policy meeting on Wednesday. Comerica Bank forecasts the Fed will authorize another 75-basis-point hike in November, followed by a half-point in December and a quarter-point in February—putting the Fed funds target at a “very restrictive” range of 4.5% to 4.75%. Others are more hawkish: In a weekend note, Goldman Sachs chief economist Jan Hatzius said the Fed will act more aggressively, hiking past its February meeting to a top rate of 5%. That would be the highest rate in 15 years.

Key Background

With prolonged inflation forcing central banks to hike interest rates aggressively this year, pockets of the economy have started to suffer immensely—particularly the housing and stock markets. A growing number of economists are worried additional rate hikes could further tank the economy, but Fed officials have remained steadfast in their commitment to lower inflation—even if it means risking a recession. In meeting minutes last month, the Fed said additional hikes would help prevent the “far greater economic pain” associated with high inflation and added that the cost of taking too little action “likely” outweighs the cost of taking too much.

Further Reading

Consumer Prices Rose Even Faster Last Month—Here’s What That Means For The Next Interest Rate Hikes (Forbes)

Economy Survives Technical Recession—But Worst Could Come Next Year, Experts Warn (Forbes)