By Cary Springfield, International Banker
In mid-July, economists at Bank of America (BoA) forecast that the US would experience a “mild recession” before the end of the year. “A number of forces have coincided to slow economic momentum more rapidly than we previously expected,” the group headed up by BoA’s new chief economist Michael Gapen said, with Bloomberg quoting those forces as being “inflation from food and energy prices that leave households with less available for discretionary purchases, and tighter financial conditions, with higher mortgage rates denting affordability.”
Indeed, inflation lies at the heart of the US’ economic woes at present, and will likely to weigh on American citizens’ cost-of-living for much of the rest of the year. Consumer price inflation for June was reported in mid-July to have climbed to 9.1 percent – the highest level since November 1981 as rising fuel costs stemming from the war in Ukraine and global supply-chain disruptions have sent prices skywards in recent months. Prices were already experiencing upward pressure last year as the US economy reopened following the COVID-19 pandemic-induced shutdowns and the massive fiscal stimulus injected into the economy in early-2021. Such factors are now prompting the Federal Reserve to raise interest rates sharply, but doing so could well initiate a “hard landing” whereby the economy is sent plummeting into recession territory, officially defined as negative economic growth for two consecutive quarters.
As such, BoA has pencilled in a decline of 1.4 percent of gross domestic product in the fourth quarter from a year earlier, followed by an increase of 1 percent in 2023, which should boost the unemployment rate by 1 percent and thus help to cool inflation. The Bank also anticipates that the Federal Reserve will raise its benchmark federal funds rate to a target range of 3.25-3.5 percent by the end of 2021. “We think that the Fed will look at the labor-market data and inflation data and conclude that it needs to keep moving at a rapid clip,” Gapen told Bloomberg.
BoA is not the only major Wall Street institution forecasting a US recession. TD Bank, for instance, puts the probability of a recession materialising at over 50 percent. According to Richard Kelly, head of TD Securities’ global strategy division, the unenviable combination of soaring gas prices, a slowing economy and the hawkish policies being implemented by the Federal Reserve represents a palpable threat to the US economy at present. “We haven’t even hit the peak lags from gas prices, and Fed hikes really won’t hit until the end of this year. That’s where the peak drag is in the economy. I think that’s where the near-term risk for a U.S. recession sits right now,” Kelly explained to CNBC on July 11. “Then, if you get past that, there’s the overall gradual slowing as we get into probably the middle or back half of 2023.”
But even if a mild recession does transpire, would it be so disastrous if it ultimately means bringing inflation back consistently to the Fed’s 2 percent target? After all, we are currently witnessing price growth spiralling out of control at a time when unemployment is close to multi-decade lows. From that perspective, a period of aggressive rate-tightening that can reset inflation-expectations whilst only raising unemployment marginally – and thus still keeping it an absolute low – could well be considered by policymakers as making the best of a bad situation.
Indeed, a June survey of economists by the Wall Street Journal (WSJ) put the probability of recession within 12 months at 44 percent which was markedly higher than the 28 percent recorded in the Journal’s previous survey in April and the 18 percent recorded in January. And according to the financial news publication itself, a 44 percent recession probability “is seldom seen outside of an actual recession,” with the December 2007 and February 2020 readings – both just prior to major US downturns – at 38 percent and 26 percent probabilities, respectively. “We now believe the U.S. economy is headed for a mild recession in the coming months,” said Greg Daco, chief economist for consulting firm EY-Parthenon, and one of those surveyed by the WSJ. “While consumers will continue to spend freely on leisure, travel and hospitality over the summer, a persistently elevated inflation backdrop, surging interest rates and plunging stock prices will erode spending power, severely curtail housing activity and constrain business investment and hiring.”
But perhaps even more notable from this latest survey is that most economists did not predict a significant rise in jobless numbers accompanying any such recession. “They forecast a 3.9 percent unemployment rate at the end of this year and a 4.6 percent unemployment rate at the end of 2023. The US has never had a recession in the post-World War II era with a jobless rate that low,” the WSJ noted.
Even Fed Chair Jerome Powell has tacitly admitted that a recession could well arise as a bi-product of efforts to tame inflation. “It’s not our intended outcome at all, but it’s certainly a possibility,” Powell admitted on June 22 at a congressional hearing. “We are not trying to provoke and do not think we will need to provoke a recession, but we do think it’s absolutely essential” to bring down inflation. As such, the Fed is currently pursuing a rate-tightening cycle, the intensity of which has not been seen since the 1980s. “We’re looking for…compelling evidence that inflation is coming down, and we don’t have that,” Powell added. “There are lots of stories out there about how this should happen, and some people think it’s very clear that it will. Until we actually do see it happen, we need to keep moving.”
But is a recession now all but guaranteed? Some would suggest not given that the impact which some factors previously had on sending US inflation to 40-year highs may have now be waning. Specifically, energy prices may have already peaked, as oil prices have recently shown signs of heading more permanently below $100/barrel. And should Russia be successful in securing important food corridors through the Black Sea, food inflation is also very likely to cool.
Indeed, not everyone believes the US is destined for a recession. “I don’t think we need a recession to get inflation back in,” Moody’s chief economist Mark Zandi recently explained to Australian Financial Review’s “What Goes Up” podcast. “Oil prices are going to roll over. Natural gas prices are going to fall. We’re going to see vehicle prices come down as supply-chain issues iron themselves out and we get more vehicle production. Commodity prices, goods prices more broadly, are going to come in.”
Robust consumer spending might also help the US avoid recession in the end, with the recent results of American banking majors confirming that consumers continue to demonstrate significant confidence in the economy. According to JPMorgan, for example, credit and debit card spending is up 15 percent year-over-year; and while consumers are having to pay much more for gas, travel and dining activity still jumped by a “robust” 34 percent. “You can see how resilient the consumer is in the US through the elevated payment rates and the low level of credit losses,” Citi CEO Jane Fraser recently remarked on an analyst call.
And the banks themselves continue to perform solidly, further strengthening the case against a looming recession. Despite apportioning more in loan loss provisions, lenders are not experiencing any considerable rise in non-performing loans as of yet. “If you didn’t look at anything else — you just looked at the bank numbers — you wouldn’t be thinking there’s a recession around the corner,” Mark Conrad, a portfolio manager at Algebris Investments, told CNN on July 18.
Ultimately, then, much depends on how long this bout of inflation will persist as to whether the US economy can achieve the soft landing the Fed so desires. Improvements in the Ukraine situation would go a long way towards helping the US achieve this goal, but major breakthroughs do not appear to be forthcoming as yet. And should a stalemate persist for much of the remainder of the year and inflation remain near current levels, one wonders what price the Fed and Powell are willing to pay to reset inflation expectations.