There is a threat of a “real” recession, which will lead to drastic interest rate cuts by the Fed

Down Angle Symbol A symbol in the form of an angle pointing downwards. In this photo taken while zooming in with a slow shutter speed, Federal Reserve Board Chairman Jerome Powell speaks during a news conference about Federal Reserve monetary policy, Wednesday, Dec. 13, 2023, in Washington. Alex Brandon/` Photo

• Economist Frances Donald told Bloomberg TV that a stronger reversal from the Fed was imminent.
• A slowdown in the US labor market could result in two quarters of negative growth at the end of the year.
• If that happens, the central bank will have to ease monetary policy quickly and beyond market expectations.

Markets are rightly pricing in a policy shift from the Federal Reserve, but should prepare for a steeper-than-expected rate-cutting cycle, economist Frances Donald told Bloomberg TV.

“What we didn't accept is that this would be a two-or-three situation, that this would be insurance cuts,” she said. “We believe we are heading towards a real downturn that requires a proper easing cycle.”

Futures markets are expecting two rate cuts of 25 basis points each towards the end of this year. That reflects renewed optimism among investors after April's jobs report came in weaker than expected, quashing fears that the Fed may have to keep interest rates high or even raise them again.

But for Manulife Investment Management's chief economist, this weakness should also be a cause for concern as it makes a recession seem all the more likely.

“Almost everything in the labor market that explains where we are in the work cycle points to deterioration,” Donald said. “We are not saying it is a major crisis, we are calling for two quarters of negative GDP – Q3 and Q4, possibly Q4 and Q1.”

While she acknowledged that her team has been anticipating a recession for some time, incoming data continues to confirm that the likelihood of a downturn is much higher than the likelihood of a reacceleration, she said.

These include household and temporary employment statistics, consistent data on job losses, declining quit rates and a decline in small business hiring.

The weakening labor market also bolsters recession predictions from veteran forecaster Danielle DiMartino Booth, who told Bloomberg on Monday that the U.S. is already in a downturn. This is based on an indicator that tracks unemployment over a 12-month period.

As the US economy slows, Donald expects current interest rates to become increasingly unsustainable, which explains why the Fed needs to pivot quickly.

“The average time between the first rate hike and its impact on businesses and consumers is two years. So we are not leaving the period when interest rate increases have a real impact on the economy,” she said. “We are entering this time.”

She previously pointed out that the Fed's inability to cut rates sooner rather than later increases the risk of something breaking in the near term.