A recession is now likely next year, say most economists. But so far, the grim warning has been accompanied by this silver lining: Any downturn will almost certainly be mild.
In recent weeks, however, the odds of a more serious downturn that will mean several million job losses have increased, they say.
Some economists blame a Federal Reserve that is aggressively raising interest rates in a single-minded mission to tame stubbornly high inflation, even as it risks a recession.
“If the Fed continues to raise interest rates, it could cause more damage,”[ads1]; said Bob Schwartz, senior economist at Oxford Economics.
Economists also point to heightened economic woes in Europe, Chinese covid-19 shutdowns that could escalate this winter, a sharp U.S. housing decline and even a U.S. labor market that has been so resilient as to prompt even bolder Fed action, among other factors.
Will there be a recession in 2022?
The most likely scenario remains a modest recession lasting six to nine months or so. Eighty-eight percent of economists predict a slowdown will be mild, according to a survey earlier this month by Wolters Kluwer Blue Chip Economic Indicators. But that is down from 95% in October. This means that the proportion of death sentences has risen to 12% from 5% within a few weeks.
What is a mild recession?
A mild recession could cost the economy 1.8 million jobs if the nation’s gross domestic product, or economic output, falls 1.2 percent and the unemployment rate rises from a 50-year low of 3.5 percent to 5.4 percent, Wells Fargo estimates chief economist Jay Bryson.
That outcome would be roughly similar to recessions in the early 1990s and early 2000s and less severe than the average downturn in which GDP falls 1.6%, said Bryson and Joseph LaVorgna, chief economist at SMBC Capital Markets.
It would also be far less damaging than the Great Recession of 2007-09 (with a nearly 4% decline in output and 8.7 million job losses) and the 2020 COVID-19 recession (with roughly a 10% decline in output, and 22 million job losses).
Consumers’ vision darkens:Consumers feel less happy ahead of the holiday season. What this could mean for expenses
Buy now, pay…much later?:Buy now, pay later defaults can be “dangerously” high. What will the companies do about it?
What is a severe recession?
A severe recession could mean 3 to 4 million job losses, a 2% to 2.5% decline in GDP, and a 7% unemployment rate, says Bryson.
Such a downturn, he says, is likely to last longer, perhaps a year or 15 months, as a virulent cycle takes hold, with widespread layoffs leading to less consumer spending, which will spur more layoffs.
Most economists predict a mild slowdown because consumers and businesses are in good shape financially and therefore have at least some means to continue spending even if the economy weakens and some people lose their jobs. Household debt was 9.6% of disposable personal income in the second quarter, up from 8.4% early last year, but well below the peak of 13.2% in late 2007 and the average over the past 40 years, according to the Federal Reserve.
In addition, 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, the outstanding debt of non-financial companies hit a record $12.5 trillion in the second quarter, but it accounted for just 3.7% of corporate profits, down from 4.8% at the end of 2019, according to the Fed and Oxford Economics. And despite sharply rising interest rates, many companies refinanced their debt when interest rates were low, says Bryson. Seventy percent of it will not reset to new prices for 12 months or longer.
Nor is the economy characterized by imbalances, as it was during the commercial property crisis of the early 1990s, the dot bust in 2000 and the housing crash of the late 2000s, says Ian Shepherdson, chief economist at Pantheon Macroeconomics.
Still, several emerging forces can turn a mild recession into a severe one:
Even bigger interest rate increases at the Fed
The Fed has already raised its key interest rate from near zero to a range of 3% to 3.25% this year – the most aggressive campaign since 1980 – and has signaled it will increase it by another 1.25 percentage points by the end of the year. Futures markets expect another half-point increase in early 2023, bringing it to a level designed to limit economic growth.
The central bank has repeatedly increased the pace of the increase despite growing recession risks, citing inflation that hit a new 40-year high early this year and has since hovered just below that level.
If inflation continues to decline more slowly than expected, the Fed could raise interest rates even higher and keep them there even as the economy falters.
“If they raise interest rates to 5% and more, that could do real damage to the economy,” says Schwartz.
Fed rate hikes have already squeezed the housing market, with 30-year fixed mortgage rates more than doubling to around 7% this year, and will increasingly dampen car purchases, credit card use and business investments, Schwartz and LaVorgna say.
Also, says LaVorgna, the Fed is raising interest rates for the first time even while the economy is slowing 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 reverse course before that happens.
Is the job market too strong?
The number of vacancies has decreased from an almost record 11.2 million in July to remain robust 10.1 million the following month. Due to persistent labor shortages, many businesses are reluctant to lay off workers or drastically reduce hiring due to fear that they will not be able to find employees when the economy recovers.
Normally, a robust labor market helps cushion an economy against a recession. But now it is likely to spur the Fed to continue raising interest rates aggressively to curb wage growth that has contributed to inflation. This may increase the risk of a deeper downturn
“They’re trying to take the steam out of the labor market without causing a recession,” says Bryson. “It’s a very tough thing to do.”
A Deutsche Bank survey out this week says the Fed will need to raise interest rates enough to push unemployment near 6 percent to lower inflation near its 2 percent target by the end of 2024.
Will house prices go down in 2023?
Sales of existing homes fell for the eighth consecutive month in September. Home prices fell for the second straight month in August for the first time since 2011, according to the Federal Housing Finance Agency House Price Index.
Housing, mostly through new construction, makes up just 4.6% of the economy, Schwartz says, adding that he’s not worried the sector is contributing to a severe recession. In addition, the market does not look like it did in 2007, when banks handed out millions of subprime loans to unqualified borrowers, leading to massive foreclosures and layoffs.
But Gregory Daco, chief economist at EY-Parthenon, says housing wealth makes up about half of households’ total net worth. He expects house prices to be 6% high by mid-2023.
“Rapidly falling prices could dampen household consumption and reinforce the recessionary dynamics expected to grip the economy in 2023,” Daco wrote in a note to clients.
Could a deep recession in Europe affect the US?
Goldman Sachs now expects winter weather to trigger a more severe European downturn, one fueled by skyrocketing energy prices linked to Russia’s war with Ukraine.
S&P 500 companies generate about 14% of their revenue from sales in Europe, according to FactSet. Bryson is concerned that a deeper downturn could further dampen the outlook and investment of US companies.
Could COVID in China affect the US?
Chinese cities are already imposing lockdowns to prevent the spread of COVID-19. Bryson worries that those efforts could intensify if a harsh winter triggers more cases, exacerbating supply chain bottlenecks for American companies. These snarls have eased, reduced product shortages and raised hopes of a drop in inflation. .
Could your company’s debt be a problem?
Even if corporate debt levels are manageable, a slowing economy can hurt earnings growth, leaving companies with less cash to pay, said Oren Klachkin, Oxford’s leading US economist. S&P 500 earnings are projected to rise 1.5% for the third quarter, the slowest clip since 2020, FactSet says.
That could further hammer business investment and cause US banks to restrict lending even more.
“It’s a potential catalyst for more severe economic and financial stress,” says Klachkin.
What is the risk of an unforeseen financial crisis?
Sharply rising interest rates can lead to crises that aren’t even on anyone’s radar, such as the implosion of the mortgage-related derivatives market in 2007, says Schwartz.
It could be a foreign country’s debt crisis as interest rates rise and a strong dollar makes repayment more challenging, or a surprised hedge fund, he says.
“It’s the unknown,” says Bryson.