Recession probability soars as inflation worsens

The likelihood of a recession has increased rapidly this year as inflationary pressures remained strong and the Federal Reserve took increasingly aggressive action to tame them. Economists on average put the probability of the economy being in recession sometime in the next 12 months at 28% in the Journal’s last survey in April and at 18% in January.

Since the Journal began asking the question in mid-2005, a 44% recession probability is seldom seen outside of an actual recession. In December 2007, the month that the 2007-to-2009 recession began, economists assigned a 38% probability. In February 2020, when the last recession began, they assigned a 26% probability.

Forecasters have raised recession probability due to a number of factors: higher borrowing costs, a blistering pace of inflation, supply-chain problems and commodity-price shocks stemming from the war in Ukraine. Mostly, however, they see dimming chances that a steeper path of rate increases by the Fed can cool inflation without inducing higher unemployment and an economic downturn.

“The Fed is slamming on the brakes. It is hard to avoid a recession…in this situation," said Michael Moran, chief economist at Daiwa Capital Markets America Inc.

The latest survey’s results showed a marked increase in economists’ forecast for inflation, which they see ending the year at 7%, up from 5.5% in the April survey. The poll of 53 economists was conducted June 16 to 17, after the Fed voted to sharply raise the benchmark federal-funds rate by 0.75 percentage point to a range between 1.5% and 1.75%.

Economists see the federal-funds rate at roughly 3.3% at the end of this year, up from 2% in the survey two months ago. That implies at least three more increases of 0.5 percentage point in 2022. The Fed has signaled it would continue lifting rates this year at the most rapid pace in decades to fight inflation that is running at a 40-year high.

“We now believe the U.S. economy is headed for a mild recession in the coming months," said Greg Daco, chief economist for EY-Parthenon, a consulting firm. “While consumers will continue to spend freely on leisure, travel and hospitality over the summer, a persistently elevated inflation backdrop, surging interest rates and plunging stock prices will erode spending power, severely curtail housing activity and constrain business investment and hiring."

Economists expect unemployment to rise as the Fed raises rates, although they see it staying at relatively low levels by historical comparison. On average, they forecast unemployment rising from 3.6% in May to an average of 3.7% at the end of 2022 and 4.2% at the end of 2023.

One bright spot is that economists still expect the economy to grow this year, although they slashed their growth projection in half in the most recent survey. On average, they see inflation-adjusted gross domestic product rising 1.3% in the fourth quarter of 2022 from a year earlier, down from 2.6% in the April survey. Last year the economy grew 5.5%, the fastest since 1984, following a 2.3% drop in 2020 when the pandemic began.

Recent data suggest the U.S. economy is starting to slow under the combined weight of soaring inflation and climbing interest rates—including the highest mortgage rates since 2008.

Economists have slashed their projections for second-quarter output growth in recent days. One closely watched model—the Federal Reserve Bank of Atlanta’s GDPNow tracker—estimates that gross domestic product is on track to remain unchanged at an annual rate over the three months through June 30. Output fell at a 1.5% annual rate in the first quarter.