Taking stock of the current macroeconomic environment

The macroeconomic environment is a frequent topic of discussion among CFOs, investors, and board members at the moment. While no one has a crystal ball, it is fair to assume that a recession is coming. The question is how deep it will be and how long it will last. The best any organization can do now is to consider different scenarios and sensitize its key business drivers to ensure it has the capital and liquidity needed. Diversifying sources of revenue away from cyclical sources is also a wise idea.

How did we get here?

The environment certainly does not seem nearly as harsh as it was during the 2008 crisis, but it is also very difficult to read because so many unusual factors have led us to where we are today. I thought it was worth taking a moment to reiterate the factors at play as we all contemplate where the economy might go.?

During the pandemic, historic levels of government transfers boosted income while spending was severely limited by social distancing. This led to the personal saving rate soaring to over 30% (historic average 8.83%). US households accumulated about $2.3T in savings through the summer of 2021, above and beyond what they would have saved in normal times. In addition to the extra savings, unemployment quickly recovered from the initial pandemic impact. The country lost around 250,000 working men and women to COVID-19, while another 2 million are still suffering from long COVID and can’t work full-time. Another 2 million workers did not come to the US due to border closures at the time. With high employment rates, wages increased, further adding to savings.

Once the country opened up, consumers were flush with cash and started spending, and actually started saving less than before the pandemic, adding even more to their spending capacity. And with interest rates at historic lows at that point, it was easy to use debt to sustain spending capacity. At the same time, a global supply chain crisis unfolded, triggered by labor shortages, border closures, and misalignment between demand patterns and production capacities. The Russian invasion of Ukraine then led to gas shortages, further disrupting supply chains. Prices started climbing, with inflation passing 9% in June 2022.

Consumer discipline and frugality are typically the first line of defense against inflation since consumer spending represents over two-thirds of economic activity. The Fed influences consumer spending through interest rates, making consumer debt more expensive but more importantly making corporate debt and capital more expensive, generally impacting employment and therefore consumer income and ability to spend.

So the Fed finally started raising interest rates in March 2022 when inflation was already over 8%. The Fed interest rate is now close to 5%, the highest since 2007. The Fed even increased rates after the recent scare over the impact to the banking system.?

What now?

We are finally starting to see the impact. Inflation finally eased last month to its lowest level in almost two years at 5%. Consumer savings rate just started increasing again in the past couple of months. We are also seeing tightening in credit standards (which started late 2022 in the Senior Loan Officer Survey, and accelerated post bank failures) and early signs of increased delinquencies, with banks building up their loan loss reserves and bankruptcy filings rising. Commercial real estate, in particular, is likely to be the next big issue to tackle with converging pressures.

GDP, however, seems to be still growing and unemployment is at 3.6%, the lowest in over 50 years. Although there are stories every day about layoffs, many seem to be for gesturing or are more still than offset by hiring in smaller companies (which accounted for a record-breaking 71.4% of all job openings at the end of February). I heard anecdotally that 40% of people laid off in tech found a job within a week.

It takes time to see the effects of rate hikes, but unemployment will go up, and GDP will slow down. The question is when and how much. The Fed will have to balance many conflicting factors in May, with the potential national debt ceiling crisis further complicating the situation.

Bracing for the storm

We know a storm is coming, but we do not know when, how, and how bad it will hit. I live in Miami, Fl. Come hurricane season, we stock up on supplies and we lay out a number of contingency plans depending on the likelihood, severity and timing of potential storms, then we go about our lives. We don't panic, because we are prepared. Successful businesses do the same. They prepare, ensuring they have the capital and culture to face the storm, then remain calm and put out the fires or grab the opportunities as they come, without panic or overreaction, with an eye far ahead on the clear horizon. Just as preparing for a hurricane can mean the difference between survival and destruction, proactive planning - not premature overreaction - in business can make all the difference in weathering economic storms and emerging stronger on the other side.

What are your companies forecasting and planning for? What steps are you taking to be prepared? How are you making sure you stay calm and don't overreact or react prematurely?