Is a recession looming?

Employment may be holding up for now but rising recessionary signals point to troubled times ahead, writes Cormac Lucey

For some time now, recessionary signals have   been building up. Looking back over half a century, recessions tend to follow a distinct path. 

First, central banks raise interest rates and tighten financial conditions. Second, the sectors most exposed to interest rates – construction and property – begin to suffer. 

Third, the next most exposed sectors – banking and finance – undergo financial stress. And finally, deflationary pressures hit the general economy and the employment market suffers. 

Midway through 2023, we have already hit stages one, two and three. 

After a slow start, the European Central Bank has raised rates at a faster pace than ever before. The property sector is already suffering. Shares in the Irish Residential Properties REIT have dropped by about 40 percent over the last nine months. 

And while the share prices of Irish banks have been holding up well, there is an air of subdued panic across the entire banking sector following the collapse of Silicon Valley Bank, Credit Suisse and First Republic. 

Like characters in an Agatha Christie thriller, banks are anxiously wondering who will be next to be written out of the script. 

So far, though, labour markets remain firm. In March, Ireland’s unemployment rate was 4.3 percent, a smidgen above the 3.9 percent minimum achieved in 2000/2001. 

There are two features of this economic cycle that may be delaying the labour market’s rendezvous with recession. These features apply to Ireland and across the Western world. 

First, following the massive fiscal splurge to cushion the economic effects of COVID-19, people on both sides of the Atlantic have hefty cash positions, making them less sensitive to interest rate hikes. 

The latest Central Bank of Ireland quarterly financial accounts show that, comparing September 2022 with March 2020, Irish households’ financial assets have grown by €79.6 billion (19%) while their net worth has grown by €253.5 billion (32%).

Second, lockdown mandates to stay at home, greater vulnerability to COVID-19 as one gets older, and the State’s pandemic splurge appear to have led a significant cohort of people to accelerate the move to retire. 

With fewer people at work, full employment can be achieved with fewer total jobs.  
But the main reason the unemployment dog has yet to bark is that employment is a lagging economic indicator. 

Changes in employment trends happen after changes in the direction of economic output. When the economy moves from growth to contraction, employers do not immediately cut their workforce. They wait until they are sure that they must. 

Many employers rushed to downsize during the pandemic and then found it difficult to recruit again once recovery arrived. Similarly, employers won’t immediately rehire once economic recovery kicks in. They will put staff on overtime while assessing the situation.
On his True Insights website, investor Jeroen Blokland has observed that, on average, the US unemployment rate rises by four percentage points in the aftermath of a significant Federal Reserve tightening cycle. “Unemployment tends to start rising after the Fed is done hiking,” he noted. 

Blokland reckons there is an average gap of about 20 months between the final Fed interest rate hike and the ensuing peak in unemployment. 

Even if the Fed announced in June that it had completed raising rates, we might have to wait until March 2025 to reach peak unemployment.

With Ireland having undergone significant private sector deleveraging since the financial crash, there is little likelihood of a self-feeding credit crunch, but our economy is highly dependent on a small number of US multinationals. 

It has been reported that, last year, Apple paid €8 billion in corporation tax to the State. This represents about €1.3 million per employee. It contrasts with the roughly €60,000 Apple paid on corporation tax for each employee outside Ireland. 

It’s a fragile foundation on which to build the public finances. 

Cormac Lucey is an economic commentator and lecturer at Chartered Accountants Ireland