Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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The velocity of money does not suggest a U.S. recession is imminent
Christopher Dembik
Head of Macroeconomic Research
Summary: We are not in the recession camp. We believe that as long as the velocity of money is rising, the likelihood of a U.S. recession is low this year.
At the end of 2022, the market consensus was expecting a recession in the United States for this year. This has not happened yet. And this is unlikely to happen, in our view. This week’s employment data for February are likely to show the economy is still very resilient despite broad-based inflationary pressures and higher cost of capital. The consensus expects that job creations are back to normal in February around 200k after a strong jump in January at 507k. The unemployment rate is expected to marginally increase to 3.5 %. These are very good figures. One can say that the labor market is a lagging indicator of the business cycle. This is true. More fundamentally, we don’t see how the United States could enter a recession in the short-term with the velocity of money being on the rise. The velocity of money (V) is the rate at which money is being spent in the economy. In simpler terms, this is how fast the same “100 USD” changes hands. V is generally a function of two things: the pace of growth in the economy and growth in the money supply. We can both use M1 and M2 for the calculation of the money supply. Think of M1 as the more focused number. It includes cash and transaction deposits whereas M2 is a larger indicator and encompasses savings and money markets among other things. Conventional economic theory usually considers that the faster the money changes hands (through the daily function of an economy), the more the economy grows. This fully makes sense. The below chart shows the evolution of V since the early 1960s in the United States. After reaching a peak in the mid-1990s at 2.2, it has decreased to an historical low of 1.1 in 2020 due to the deep and broad shock related to the pandemic. This is not surprising. What is interesting is that V is now increasing, though from a low starting level. As long as V is expanding, the probably is high the U.S. economy will grow. This can be puzzling given the cost of capital is rising and inflation is hitting purchasing power. In our view, the $5tr stimulus that was triggered to fight the economic consequences of the pandemic partially explains the rise in V. Our baseline is the U.S. economy will continue to grow this year, at a lower level than in 2022 of course. But a recession is far from certain (unless it is voluntarily engineered by the U.S. Federal Reserve to tame inflation – this is not the case so far).
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