Downturns are notoriously difficult to predict, but consensus is growing among major banks and prominent economists that a downturn will come as the Federal Reserve intensifies the war on inflation.
The Fed hopes to achieve the rarest economic achievements when it enters full-fledged anti-inflationary mode: to cool consumer demand enough so that prices stop rising, without crushing it so much that it throws the country into a recession. Although Fed politicians expect to find the elusive sweet spot ̵[ads1]1; known as a soft landing – history shows that the US Federal Reserve often struggles to succeed in narrowing the gap between tightening policy and maintaining economic growth.
HOW THE FEDERAL RESERVE MADE A RISK OF INCREASING INFLATION
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Bank of America, Deutsche Bank, Wells Fargo and Goldman Sachs are among the most notable firms predicting the possibility of a recession over the next two years, as the US Federal Reserve moves to tighten monetary policy aggressively to cool consumer demand. and bring inflation back to the target of 2%.
While the economy remains fairly strong at the moment, there are growing signs that Wall Street may be right: US economic growth is already slowing, the Bureau of Labor Statistics reported earlier this month that gross domestic product unexpectedly shrank in the first quarter. year, which marks the worst performance since the spring of 2020, when the economy was still deep in the covid-induced recession.
Downturns are technically defined by two consecutive quarters of negative economic growth and are characterized by high unemployment, low or negative GDP growth, declining income and declining retail sales. But they vary greatly in how they actually manifest, which is just as difficult to predict.
Recent research by Alan Blinder, a former deputy chairman of the Federal Reserve Board and a Princeton economist identified 11 Fed tightening cycles since 1965, eight of which were followed by recessions. Most declines were very mild: there were five cases where GDP fell less than 1%, or there was no economic decline at all.
WHAT IS A RECESSION, AND SHOULD AMERICANS BE CONCERNED?
“Then we will be stuck with a recession? Maybe,” Blinder wrote in a recent Wall Street Journal issue. “The odds were probably over 50% even before [first quarter] GDP report. But it is important to note that any recession should not be deep and long, unlike those of the 1970s and early 1980s. “
The first Wall Street economists to predict a downturn – Deutsche Bank strategists, led by Matthew Luzzetti – have projected a recession beginning next April as a result of the Fed’s efforts to curb inflation. But the team said it would probably be a “mild” one, much different from the ones the Americans experienced in 2008 and 2020. It could look like several years of anemic growth, or a very short recession where GDP does not fall too much and the economy goes back relatively quickly.
The Fed already voted to raise the short-term interest rate by 50 basis points in May, and has signaled that correspondingly large increases are on the table at upcoming meetings as inflation remains close to 40 years high. Higher interest rates tend to create higher interest rates on consumer and corporate loans, which slows down the economy by forcing employers to cut spending.
Fed Chairman Jerome Powell has reiterated this sentiment in recent public forums, promising that the Fed will raise interest rates as high as necessary to cool prices.
“What we need to see is that inflation falls in a clear and convincing way, and we will continue to push until we see it,” he said last month during a live event in the Wall Street Journal. “If it involves going beyond widely understood levels of neutrality, we will not hesitate at all to do so.”
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Of course, some economists are more pessimistic about the outlook. JPMorgan Chase CEO Jamie Dimon warned of a looming economic “hurricane” this week, citing fears of rising interest rates, inflation and the war in Ukraine.
“I said it was storm clouds. But I’ll change that. It’s a hurricane,” he told a conference hosted by Alliance Bernstein Holdings. “Right now it’s a little sunny, things are going well, everyone thinks the Fed can handle it. That hurricane is right out there down the road coming our way. We do not know if it’s a smaller one or Superstorm Sandy. Get ready. “