Ever since the Federal Reserve began raising interest rates, officials at the central bank have hoped to rein in inflation without triggering a recession, achieving a so-called soft landing for the economy.
But as inflation persists at 40-year highs, investors are growing more fearful that a recession is inevitable. Uncertainty about the outlook and how aggressively the Fed will have to raise rates to keep prices from spiraling higher has sent stocks lower in volatile trading. The first half of the year was the worst for the
since 1970, fueling concerns over what is to come.
Most economists at major research firms have placed the likelihood of a recession at below 50% for the remainder of this year. Goldman Sachs, for example, sees a 30% chance of a US recession this year, while economists at Bank of America peg that likelihood at nearly 40%.
For JP Morgan economists, a soft landing remains a possibility, but that is only one of three paths the economy could take in response to the Fed’s rate increases. “The global economy faces three doors at midyear,” they write.
Behind the first door lies a recession in the second half of 2022 that causes consumers to “buckle and break” as a result of rising inflation and tightening financial conditions, they write. Strength in the labor market could offset recession risks, they add, but they still peg the likelihood of a recession driven by a break in consumer behavior—a sharp pullback in spending—at 40%.
In the second scenario, the economy skirts a recession in 2022, buoyed by strength in areas such as the labor market and consumer spending. Continued economic growth, though, could keep core inflation above 3% year over year heading into 2023, the economists say, forcing the central bank to drive rates well over 4% and induce a recession that might hit in 2023. the federal-funds rate is 1.5% to 1.75%.
The last possibility is the economists’ base-case scenario, which aligns with the Fed’s goal of a soft landing. They predict that the Fed will keep tightening policy, but won’t allow the federal-funds rate to rise past 3.5%, allowing the economy to keep expanding through 2024. There is a 42% chance this scenario plays out, they say.
“This is a ‘goldilocks’ outcome whereby near-term headwinds take sufficient steam out of the expansion but not so much so that it induces a recession,” the economists write.
The Goldilocks scenario wouldn’t be painless. There is a strong chance that it could lead to deterioration in the goods sector, the economists say. Already, the sector is looking weak, as production contracts and consumers pull back on their spending. Consumer spending adjusted for inflation dropped by 0.4% in May, the first decline since January, according to the Bureau of Economic Analysis.
Whatever door the economy does hurtle through, it will be some time before a clearer image of the second half of 2022 materializes.
Meanwhile, investors and strategists will be poring over the minutes from the Fed’s June 14-15 meeting, to be released later Wednesday, for signs about future interest-rate increases, inflation abating, and recession expectations.
Write to Sabrina Escobar at firstname.lastname@example.org