Recession risk is rising, economists say

The median economist in the survey projected that the Fed will take the federal funds rate’s midpoint range to 2.125% by the end of 2022, and then to 2.875% by December 2023—close to the Fed’s own projections (AFP)
The median economist in the survey projected that the Fed will take the federal funds rate’s midpoint range to 2.125% by the end of 2022, and then to 2.875% by December 2023—close to the Fed’s own projections (AFP)

Summary

Forecasters raise probability of economic contraction in next 12 months to 28% as Fed tightens to beat back inflation

Economists see a growing risk of recession as the relentlessly strong U.S. economy whips up inflation, likely bringing a heavy-handed response from the Federal Reserve.

Economists surveyed by The Wall Street Journal this month on average put the probability of the economy being in recession sometime in the next 12 months at 28%, up from 18% in January and just 13% a year ago.

“Risk of a recession is rising due to the series of supply shocks cascading throughout the economy as the Fed lifts rates to address inflation," said Joe Brusuelas, chief economist at RSM US LLP.

Economists slashed their forecast for growth this year. On average they see inflation-adjusted gross domestic product rising 2.6% in the fourth quarter of 2022 from a year earlier, down a full percentage point from the average forecast six months ago, though still higher than the 2.2% average annual growth rate in the decade before the pandemic.

The looming risk of a downturn alongside alarmingly high inflation, which hit 7.9% in February, captures the Fed’s balancing act: It is attempting to cool the economy enough to bring down inflation, but not so much that it spurs a pullback in spending and rising unemployment.

The latest recession probability is slightly lower than the last expansion’s peak of 34.8% in September 2019. At the time, growth had slowed in response to Fed rate increases the prior year and a trade war between the U.S. and China. Months earlier, it had kicked off its first rate-cutting cycle since 2008.

Whether a recession would have followed then, absent the pandemic, can’t be known. Economists’ recession probability reached the same level in August 2007, after which a recession did follow. But when it reached a similar level in August 2011, the economy kept growing.

Last month, the central bank lifted its benchmark rate a quarter-point and penciled in six more increases by year’s end, the most aggressive pace in more than 15 years. Some 84% of economists surveyed said they expect the Fed to raise rates by a half-point in early May. More than 57% see two or more such increases through the end of 2022.

The median economist in the survey projected that the Fed will take the federal funds rate’s midpoint range to 2.125% by the end of 2022, and then to 2.875% by December 2023—close to the Fed’s own projections.

But they also expect inflation to remain stubbornly high—predicting, on average, a 7.5% rate in June 2022, edging down to a still-uncomfortable 5.5% by December. Respondents estimate it will fall back to 2.9% by late 2023, within striking distance of the Fed’s 2% target.

High inflation remains the primary economic risk; it erodes spending power and consumer confidence and invites the Fed to tighten. Economists differ on the biggest source of inflationary risk. One-third cited commodity, food and gas prices, while 15% pinpointed Russia’s war with Ukraine.

In this camp, Amy Crews Cutts, of AC Cutts & Associates LLC, expects higher, more persistent inflation than her peers, largely because its main drivers are commodity prices, exacerbated by war in Ukraine. But though monetary policy has little impact on those prices, she said, the distressing level of overall inflation presses the Fed to act.

“To be seen not fighting it is politically unwinnable. But the only policy response the Fed has is to tighten," said Ms. Cutts, who puts the chance of a recession in the next 12 months at 70%. “Fed actions to curb inflation will lead to a recession sooner rather than later."

Twenty-seven percent of respondents pointed to wage growth or a tight labor market as the biggest inflationary threat.

“The Ukraine crisis will cause another boost to inflation in the near term, but the wage-price spiral that has started already is a more permanent threat to price stability," said Philip Marey, senior U.S. strategist at Rabobank. In such a spiral, workers win higher wages to keep up with rising prices, and then those higher wages prompt firms to raise prices further. Mr. Marey said that because that process is already under way, the Fed will have to raise rates enough to induce a recession to break the inflation dynamic.

Robert Fry, of Robert Fry Economics LLC, puts the chance of a contraction in the next 12 months at a mere 15%, but raises that to well over 50% within the coming 24 months, and currently expects a recession lasting three quarters to begin in the final quarter of 2023.

“The problem is really excess demand, resulting from last year’s fiscal and monetary policies," he said. “The longer the Fed waits to get inflation under control, the deeper the recession will be."

While recognizing the rising risk of a downturn, a majority of economists—63%—still think the Fed will be able to rein in inflation without triggering a recession—what economists call a “soft landing." Many said the economy is well positioned to withstand tightening given unemployment near record lows, steadily rising incomes and relatively subdued levels of consumer debt.

“There is still a lot of pent-up demand and momentum in the economy," said Leo Feler, a senior economist at the Anderson School of Management at the University of California, Los Angeles. “Higher interest rates may cut growth from about 4-5% to about 2-3% this year, so we’ll see a significant slowdown in growth, but a recession seems unlikely at this time."

The Wall Street Journal survey of 65 business, academic and financial forecasters was conducted April 1-5. Not all participants responded to every question. 

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