A recession is now likely next year, say most economists. But so far that grim warning has come with that silver lining: any slowdown will almost certainly be mild.
In recent weeks, however, the chances of a deeper crisis that would mean millions more job losses have increased, they say.
Some economists blame a Federal Reserve for aggressively raising interest rates as part of a single mission to rein in stubbornly high inflation, even if it risks a recession.
“If the Fed keeps raising rates, it could do more damage,” said Bob Schwartz, senior economist at Oxford Economics.
Economists also point to intensifying economic turmoil in Europe, China’s COVID-19 lockdowns that could intensify this winter, a marked slowdown in US housing, and even a US labor market that has been so resilient that ‘it prompts even bolder action from the Fed, among other factors.
Will there be a recession in 2022?
The most likely scenario is still a modest recession lasting about six to nine months. According to a survey conducted earlier this month by Wolters Kluwer Blue Chip Economic Indicators, 88% of economists predict a slowdown will be moderate. But that’s down from 95% in October. This means that the share of doomsayers has increased from 5% to 12% in a few weeks.
What is a mild recession?
A mild recession could cost the economy 1.8 million jobs if the country’s gross domestic product, or economic output, declines 1.2% and the unemployment rate rises from a 50-year low of 3.5% to 5.4%, estimates Wells Fargo chief economist Jay Bryson.
That outcome would be roughly similar to the recessions of the early 1990s and early 2000s and less severe than the average downturn in which GDP falls 1.6%, say Bryson and Joseph LaVorgna, chief economist at SMBC Capital. Markets.
It would also be much less damaging than the Great Recession of 2007-09 (with its nearly 4% drop in output and 8.7 million job losses) and the COVID-19 recession of 2020 (with a decline in 10% of production and 22 million job losses).
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What is a severe recession?
A severe recession could mean 3 to 4 million job losses, a 2% to 2.5% drop in GDP and a 7% unemployment rate, says Bryson.
Such a crisis, he says, would likely last longer, perhaps a year or 15 months, as a virulent cycle sets in, with widespread layoffs leading to lower consumer spending, which would lead to more layoffs. .
Most economists predict a mild recession because consumers and businesses are in good financial shape and therefore have at least enough to continue spending even if the economy weakens and some people lose their jobs.. Household debt stood at 9.6% of personal disposable income in the second quarter, down from 8.4% at the start of last year, but well below the peak of 13.2% at the end of 2007 and the average of the past 40 years, according to the Federal Reserve.
Additionally, consumers still have nearly $2 trillion in pandemic-related savings, though that’s down from a peak of $2.6 trillion last year, according to Moody’s Analytics.
Meanwhile, non-financial corporate debt stock hit a record high of $12.5 trillion in the second quarter, but it only accounted for 3.7% of corporate profits, down from 4.8% at the end of 2019. , according to the Fed and Oxford Economics. And despite the sharp rise in interest rates, many companies refinanced their debt when rates were low, Bryson says. Seventy percent of them won’t reset to the new rates for 12 months or more.
Moreover, the economy is not plagued by imbalances, as it was during the commercial real estate crisis of the early 1990s, the dotcom crash of 2000, and the housing crash of the late 2000s, says Ian Shepherdson, chief economist at Pantheon Macroeconomics.
Yet several emerging forces could turn a mild recession into a severe one:
Even bigger Fed rate hikes
The Fed has already raised its main short-term interest rate from near zero to a range of 3% to 3.25% this year – its most aggressive campaign since 1980 – and signaled it would raise it further. by 1.25 percentage points by the end of the year. Futures markets expect another half-point rise in early 2023, bringing it down to a level designed to restrict economic growth.
The central bank has repeatedly accelerated the pace of increases despite growing recession risks, citing inflation which hit a new 40-year high earlier this year and has since hovered just below that level.
If inflation continues to decline more slowly than expected, the Fed could drive rates even higher and hold them even as the economy falters.
“If they raise rates to 5% and beyond, it could do real damage to the economy,” Schwartz said.
Fed rate hikes have already rattled the housing market, with fixed 30-year mortgage rates more than doubling to around 7% this year, and will increasingly dampen car purchases, use credit cards and business investments, according to Schwartz and LaVorgna.
Additionally, LaVorgna says, the Fed is raising rates for the first time even as the economy slows sharply.
“If they do what they say they’re going to do, we’re going to have a deep recession,” LaVorgna says, adding that he thinks Fed officials will backtrack before that happens.
Is the labor market too strong?
Job postings fell from a near-record high of 11.2 million in July to a still-robust level 10.1 million the following month. Due to ongoing labor shortages, many companies are reluctant to lay off workers or drastically cut hiring, fearing they won’t be able to find employees when the economy rebounds.
Normally, a resilient labor market helps protect an economy against a recession. But now it will likely prompt the Fed to continue raising rates aggressively to temper wage gains that have helped stoke inflation. This could increase the risk of a deeper downturn
“They’re trying to take the steam off the job market without causing a recession,” Bryson says. “It’s a really hard thing to do.”
A Deutsche Bank study released this week indicates that the Fed will need to raise its key rate enough to push unemployment close to 6% in order to reduce inflation close to its target of 2% by the end of 2024.
Will housing prices fall in 2023?
Existing home sales fell for the eighth consecutive month in September. Home prices fell for the second consecutive month in August for the first time since 2011, according to the Federal Housing Finance Agency’s house price index.
Housing, mostly through the construction of new homes, accounts for just 4.6% of the economy, Schwartz says, adding that he’s not worried the sector is contributing to a severe recession. Moreover, the market is nothing like it was in 2007, when banks doled out millions in subprime loans to unqualified borrowers, leading to mass foreclosures and layoffs.
But Gregory Daco, chief economist at EY-Parthenon, says housing wealth accounts for about half of total household net worth. He expects home prices to hit 6% by mid-2023.
“Rapidly falling prices could dampen household consumption and amplify the recessionary momentum that is expected to grip the economy in 2023,” Daco wrote in a note to clients.
Could a deep recession in Europe spill over to the United States?
Goldman Sachs now expects wintry weather to trigger a more serious European downturn, which is driven by soaring energy prices linked to the war between Russia and Ukraine.
According to FactSet, S&P 500 companies generate around 14% of their revenue from sales in Europe. Bryson worries that a deeper downturn could further hurt the prospects and investments of U.S. businesses.
Could COVID in China impact the United States?
Chinese cities are already imposing lockdowns to prevent the spread of COVID-19. Bryson fears those efforts could ramp up if a harsh winter triggers more cases, compounding supply chain bottlenecks for U.S. businesses. Those rumblings have died down, reducing product shortages and raising hopes of lower inflation. .
Could corporate debt be a problem?
Although corporate debt levels are manageable, a slowing economy could hurt revenue growth, leaving companies with less cash to make payments, says Oren Klachkin, chief US economist at Oxford. S&P 500 earnings are expected to rise 1.5% for the third quarter, the slowest clip since 2020, according to FactSet.
That could further hammer business investment and cause U.S. banks to restrict lending even further.
“It’s a potential catalyst for more serious financial and economic stress,” Klachkin says.
What is the risk of an unforeseen financial crisis?
A sharp rise in interest rates can lead to crises that aren’t even on anyone’s radar, like the implosion of the mortgage derivatives market in 2007, Schwartz says.
It could be a foreign country’s debt crisis as interest rates rise and a strong dollar makes repayment more difficult, or an overleveraged hedge fund, he says.
“It’s the unknown,” Bryson said.
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