Why everyone thinks a recession is coming in 2023

People who have lost their jobs line up to file for unemployment following an outbreak of the coronavirus disease (COVID-19), at an Arkansas labor center in Fort Smith , Arkansas, USA, April 6, 2020.

Nick Oxford | Photo File | Reuters

Recessions often take everyone by surprise. Chances are the next one won’t.

Economists have been predicting a recession for months now, and most see it starting early next year. Whether deep or shallow, long or short, is up for debate, but the idea that the economy is entering a period of contraction is pretty much the consensus among economists.

“Historically, when you have high inflation and the Fed raises interest rates to stifle inflation, that leads to a slowdown or a recession,” said Mark Zandi, chief economist at Moody’s Analytics. “This invariably happens – the classic scenario of overheating leading to a recession. We’ve seen this story before. When inflation picks up and the Fed responds by raising interest rates, the economy eventually slumps under the weight of higher interest rates.”

Zandi is among the minority of economists who believe the Federal Reserve can avoid a recession by raising rates just long enough to avoid crushing growth. But he said expectations are high that the economy will slump.

“Usually recessions surprise us. CEOs never talk about recessions,” Zandi said. “Now it seems like CEOs are breaking down to say we’re falling into a recession. … Every person on TV says recession. Every economist says recession. I’ve never seen anything like it.”

Fed causing it this time

Ironically, the Fed is slowing the economy, having come to the rescue in the last two economic downturns. The central bank helped boost lending by bringing interest rates down to zero and boosted market liquidity by adding trillions of dollars of assets to its balance sheet. It is now unwinding that record and quickly raising interest rates from zero in March – to a range of 4.25% to 4.5% this month.

But during these last two recessions, policymakers need not have worried about high inflation, which weighed on the purchasing power of consumers or businesses, and spread through the economy through the supply chain. and rising wages.

The Fed now has a serious battle against inflation. He plans further rate hikes, to around 5.1% by early next year, and economists expect he can keep those rates high to control inflation.

Those higher rates are already weighing on the housing market, with home sales falling 35.4% from a year ago in November, the 10th consecutive month of decline. The mortgage rate over 30 years is close to 7%. And consumer inflation was still running at a high annual rate of 7.1% in November.

“You need to blow the dust off your economics textbook. This is going to be a classic recession,” said Tom Simons, money market economist at Jefferies. “The transmission mechanism that we’re going to see working first at the start of next year, we’re going to start to see significant margin compression in corporate earnings. Once that starts to set in, they’re going to take measures to reduce their spending. The first place we’re going to see it is in downsizing. We’ll see it by the middle of next year, and that’s when we’ll see economic growth will slow down significantly and that inflation will also decline.”

How bad will that be?

A recession is considered a prolonged economic downturn that widely affects the economy and usually lasts two or more quarters. The National Bureau of Economic Research, the arbiter of recessions, considers the depth of the downturn, its extent and its duration.

However, if a factor is severe enough, the NBER could declare a recession. For example, the pandemic downturn in 2020 was so sudden and sharp with far-reaching impact that it was determined to be a recession even though it was very short-lived.

“I’m hoping for a short and shallow, but hope is eternal,” said Diane Swonk, chief economist at KPMG. “The good news is that we should be able to recover quickly. We have good balance sheets and you might get an answer to lower rates once the Fed starts easing. Fed-induced recessions are not recessions. balance sheet.”

The Federal Reserve’s latest economic projections show the economy growing at a rate of 0.5% in 2023, and it does not foresee a recession.

“We will have one because the Fed is trying to create one,” Swonk said. “When you say growth is going to stall at zero and the unemployment rate is going to go up…it’s clear the Fed has a recession in its forecast, but it won’t say that.” The central bank expects unemployment to rise next year to 4.6% from 3.7% currently.

Reversal of the Fed?

How long policymakers can keep interest rates high is unclear. Futures market traders expect the Fed to start cutting rates by the end of 2023. In its own forecast, the central bank forecasts rate cuts starting in 2024.

Swonk thinks the Fed will have to pull back to higher rates at some point because of the recession, but Simons expects a recession could continue through the end of 2024 in a period of high rates.

“The market clearly thinks the Fed is going to reverse course in rates as things go down,” Simons said. “What is not appreciated is that the Fed needs it to maintain its long-term credibility on inflation.”

The last two recessions came after shocks. The 2008 recession started in the financial system, and the impending recession will look nothing like that, Simons said.

“It became virtually impossible to borrow money even though interest rates were low, the flow of credit slowed a lot. Mortgage markets were broken. Financial markets suffered due to contagion derivatives,” Simons said. “It was generated financially. It wasn’t so much the Fed’s tightening policy by raising interest rates, but the market closed due to a lack of liquidity and confidence. I don’t think we let’s have it now.”

This recession has been longer than it looked in retrospect, Swonk said. “It started in January 2008. … It was like a year and a half,” she said. “We had a year where you didn’t know you were in it, but technically you were. … The pandemic recession lasted two months, March, April 2020. That’s it.”

While the potential for a recession has been on the horizon for some time, the Fed has so far failed to really slow employment and cool the economy through the labor market. But announcements of layoffs are increasing and some economists see a potential drop in employment next year.

“At the beginning of the year, we received 600,000 [new jobs] a month, and now we get maybe around 250,000,” Zandi said. “I think we’ll see 100,000, then next year it will drop to zero. … It’s not enough to cause a recession, but enough to cool the labor market.” He said there could be a drop in employment next year.

“The irony here is that everyone is expecting a recession,” he said. It might change their behavior, the economy might cool down, and the Fed wouldn’t have to tighten to the point of stifling the economy, he said.

“Debt service burdens are at an all-time low, households have a boatload of cash, companies have good balance sheets, profit margins are rolled over, but they’re near record highs,” Zandi said. “The banking system has never been so well capitalized or so liquid. Every state has a rainy day fund. The housing market is underbuilt. It’s usually oversized before a recession. … The basics of the economy seem solid.”

But Swonk said policymakers won’t give up the fight against inflation until they believe it’s winning. “Seeing this hawkish Fed makes it harder to argue for a soft landing, and I think that’s because the better things get, the more hawkish they need to be. That means a more active Fed,” a- she declared.

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