A recession is now likely next year, most economists say. But so far this dire warning has been accompanied by this silver lining: any downturn will almost certainly be mild.
In recent weeks, however, the chances of a deeper slump that would mean millions more jobs have increased, they say.
Some economists blame a Federal Reserve that is aggressively raising interest rates to curb stubbornly high inflation, even at the risk of a recession.
“If the Fed keeps raising rates, it could do even more damage,” says Bob Schwartz, senior economist at Oxford Economics.
Economists are also pointing to worsening economic problems in Europe, Chinese COVID lockdowns that could escalate this winter, a sharp slowdown in the US housing market, and even a US job market that has been resilient enough to resist, among other things bolder action by the Fed.
Will there be a recession in 2022?
The most likely scenario is still a mild recession lasting around six to nine months. According to a Wolters Kluwer Blue Chip Economic Indicators survey earlier this month, 88 percent of economists are forecasting a slight downturn. But that’s down from 95% in October. This means that the proportion of naysayers has climbed from 5% to 12% within just a few weeks.
What is a mild recession?
A mild recession could cost the economy 1.8 million jobs if the country’s gross domestic product, or economic output, falls 1.2% and the unemployment rate rises to 5.4% from a 50-year low of 3.5%, estimates say Jay Bryson, Chief Economist of Wells Fargo.
That outcome would be roughly similar to the recessions of the early 1990s and early 2000s and would be less severe than the average downturn, which sees GDP fall 1.6%, say Bryson and Joseph LaVorgna, chief economists at SMBC Capital Markets.
It would also be far less damaging than the Great Recession of 2007-09 (with output down nearly 4% and 8.7 million job losses) and the 2020 COVID recession (with output down about 10% and 22 million jobs). Losses).
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What is a severe recession?
A severe recession could mean the loss of three to four million jobs, a 2% to 2.5% drop in GDP and a 7% unemployment rate, says Bryson.
Such a slump, he says, would likely last longer, perhaps a year or 15 months, given a virulent cycle of widespread layoffs leading to lower consumer spending, which would lead to more layoffs.
Most economists are forecasting a slight dip because consumers and businesses are financially strong and therefore have at least some cash to keep spending even as the economy weakens and some people lose their jobs. Household debt amounted to 9.6% of disposable personal income in the second quarter, up from 8.4% early last year, but well below the 13.2% peak in late 2007 and the average over the past 40 years, the sources said Federal Reserve.
Also, consumers still have nearly $2 trillion in pandemic-related savings, according to Moody’s Analytics, although that’s down from a peak of $2.6 trillion last year.
Meanwhile, non-financial corporations’ outstanding debt hit a record high of $12.5 trillion in the second quarter, but accounted for just 3.7% of corporate earnings, according to the Fed and Oxford Economics, up from 4.8% at the end of 2019. And despite sharply rising interest rates many companies refinanced their debt when interest rates were low, says Bryson. Seventy percent of these will not reset to new rates for 12 months or more.
Also, the economy isn’t being plagued by imbalances like it was during the commercial housing crisis of the early 1990s, the dot-com crisis of 2000, and the housing crisis of the late 2000s, says Ian Shepherdson, chief economist at Pantheon Macroeconomics.
Still, several emerging forces could turn a mild recession into a severe one:
Even bigger Fed rate hikes
The Fed has already raised its short-term interest rate from near zero to a range of 3% to 3.25% this year – the most aggressive campaign since 1980 – and has signaled that it will hike it another 1.25 percentage points by the end of the year the year. Futures markets are expecting another half-point rise in early 2023, a level said to limit economic growth.
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The central bank has repeatedly increased the pace of rate hikes despite mounting recession risks, leading inflation, which hit a new 40-year high earlier this year and has hovered just below that level since.
If inflation continues to ease at a slower-than-expected pace, the Fed could hike rates even higher and keep them there even as the economy falters.
“If they hike interest rates to 5% and above, it could do real damage to the economy,” Schwartz says.
The Fed’s rate hikes have already hurt the housing market, with rates on 30-year fixed-rate mortgages more than doubling to about 7% this year and increasingly dampening car purchases, credit card use and business investment, Schwartz and LaVorgna say.
In addition, LaVorgna says, the Fed is raising rates for the first time even as the economy slows sharply.
“If they do what they promise, we’re going to have a deep recession,” LaVorgna says, adding that he believes Fed officials will change course before that happens.
Is the labor market too strong?
Job vacancies have fallen to a still robust level from a record 11.2 million in July 10.1 million the following month. With ongoing labor shortages, many companies are reluctant to lay off workers or severely limit hiring, fearing they will not be able to find employees when the economy recovers.
Typically, a resilient labor market helps cushion an economy against a recession. But now it will likely spur the Fed to continue raising rates aggressively to dampen wage increases that have helped fuel inflation. That could increase the risk of a deeper downturn
“They’re trying to take steam out of the job market without triggering a recession,” says Bryson. “It’s a really difficult thing.”
A Deutsche Bank study released this week says the Fed needs to raise interest rates far enough to push unemployment down to nearly 6% and bring inflation close to 2% by the end of 2024.
Will house prices fall in 2023?
Existing home sales fell for the eighth straight month in September. According to the Federal Agency for Housing Finance’s house price index, home prices fell in August for the second month in a row for the first time since 2011.
Housing construction, mostly through the construction of new homes, accounts for just 4.6% of the economy, Schwartz says, adding he’s not worried the sector could contribute to a severe recession. Also, the market doesn’t look the same as it did in 2007, when banks made millions in subprime loans to unqualified borrowers, leading to massive foreclosures and layoffs.
But Gregory Daco, chief economist at EY-Parthenon, says housing wealth accounts for about half of total household net worth. He expects home prices to rise 6% by mid-2023.
“Rapidly falling prices could dampen household consumption and add to the recessionary momentum likely to grip the economy in 2023,” Daco wrote in a note to clients.
Could a deep recession in Europe spill over into the US?
Goldman Sachs now believes the winter weather will trigger an even more severe downturn in Europe, fueled by rising energy prices linked to Russia’s war with Ukraine.
According to FactSet, S&P 500 companies generate about 14% of their revenue from sales in Europe. Bryson worries that a deeper downturn could further hurt US company prospects and investments.
Could COVID in China affect the US?
Chinese cities are already imposing lockdowns to prevent the spread of COVID. Bryson worries those efforts could intensify if a severe winter sparks more cases and worsens supply chain bottlenecks for U.S. companies. These problems have eased, reducing product shortages and raising hopes of a slowdown in inflation. .
Could corporate debt be a problem?
Although corporate debt is manageable, a slowing economy could hurt sales growth and leave companies with less cash to make payments, says Oren Klachkin, Oxford’s leading US economist. S&P 500 earnings are expected to rise 1.5% for the third quarter, the slowest increase since 2020, according to FactSet.
This could further hamper business investment and prompt US banks to tighten lending even further.
“It’s a potential catalyst for even greater financial and economic strain,” says Klachkin.
How high is the risk of an unforeseen financial crisis?
Sharply rising interest rates can lead to crises that aren’t even on the radar, like the implosion of the mortgage-related derivatives market in 2007, Schwartz says.
It could be a foreign country’s debt crisis, when interest rates are rising and a strong dollar makes repayments harder, or an over-leveraged hedge fund, he says.
“It’s the unknown,” says Bryson.
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