The worst of inflation may be behind us, but recession is not

(CNN) — There was a possibility of recession in 2023.

This time last year, skyrocketing inflation was barely slowing down, leaving the Federal Reserve no choice but to raise interest rates. The S&P 500 was already in a bear market. Layoffs were increasing as companies cut costs, especially in the technology sector.

And to top it all, the Philadelphia Phillies made it to the World Series, which was historically a terrible sign for the economy, as every time a team wins it triggers a recession.

But the Phillies’ eventual loss to the Houston Astros last year was clearly a victory for the economy because the recession never occurred.

Truth be told, the reason they don’t make it in 2023 has less to do with baseball and more to do with good policies and a little luck.

Still, as the standard investment disclaimer says, past performance is no guarantee of future results.

Conditions favorable for recession in 2024

Federal Reserve Chairman Jerome Powell told reporters in December that the risk of a recession has increased after the Federal Reserve begins its tightening cycle in March 2022. However, he assured that “there are no grounds to think that the economy is now in recession.”

But even when the economy looks like it’s never been in better shape, a recession next year remains a possibility, Powell said.

This is because unexpected economic crises (such as global pandemics) can arise at any time.

Barring unexpected future events, some economists believe that under current circumstances a recession is still likely next year.

“The recession has been delayed, but not completely eliminated,” said Kathy Bostjanic, chief economist at Nationwide Mutual.

Excluding health and education, employment in the private services sector is a metric closely followed by Bostjancic. The remaining sectors of private services (such as transportation, entertainment, and hospitality) are more cyclical, meaning they are more sensitive to economic shocks. So studying the movements in that sector gives you a better idea of ​​the state of the economy, he said.

According to data from the United States Department of Labor, in November 2022, monthly hiring in the personal services sector, excluding health and education, stood at 92,000. However, the November 2023 employment report shows a sharp decline in the sector with 22,000 new hires.

Overall, job growth has been strong over the past year, helping keep the unemployment rate below 4%.

However, Bostjancic isn’t sure that will last into the new year. The economist believes there is a 65% chance of a mild recession in 2024 and predicts the unemployment rate will rise to 5% in the third quarter. That’s about one percentage point higher than Federal Reserve officials’ average estimate for the unemployment rate in 2024, according to the latest summary of economic projections.

Bostjancic predicts the decline in income due to unemployment will force consumers to reduce spending and lead to a recession, he told CNN. And unlike recent years, he said, consumers have “no extra fuel” to fall back on as the savings they built up during the pandemic are exhausted.

There is also a threat of recession from the Federal Reserve. This is because the central bank’s current high level of interest rates is intended to slow the economy to help bring inflation closer to its 2% target.

But if inflation continues to retreat and the Federal Reserve waits too long to cut interest rates, it could prevent the economy from growing, said John C. Lewis, a senior fellow at the Brookings Institution and policy director at the Hutchins Center for Fiscal and Monetary Policy. Lewis Sheiner said.

This means that it will be difficult for the Federal Reserve to determine when it is appropriate to cut interest rates, if it is appropriate to do so.

For example, Scheiner explained, because interest rates take time to spread through the economy, past actions by the Federal Reserve may have already slowed the economy enough to bring inflation closer to target, though still reflected in the data. Has not happened. If the Federal Reserve leaves interest rates unchanged, they could “accidentally” increase them and cause a recession.

On the other hand, there is also a danger that inflation will become too difficult to deal with.

“If the Fed wants everyone to believe it’s committed to getting inflation down to 2%, it’s going to have to have a recession,” Scheiner told CNN.

This could mean keeping rates higher for longer than investors currently expect, or even raising interest rates.

A case of another year without a recession

It’s not entirely out of the question that the Federal Reserve achieves a soft landing, a term used to describe a scenario in which inflation cools without a significant increase in unemployment.

Of the 11 rate-hike cycles over the past 60 years that were intended to reduce inflation, this has happened only a few times: in 1964, 1984, and 1994. But that doesn’t mean it can’t or won’t happen again. ,

David Mericle, chief US economist at Goldman Sachs, is one of those who believes in a soft landing.

“The hard part of the fight against inflation is over,” he wrote in a November note, “the conditions have been created for inflation to once again reach its objective, and the hardest shocks of monetary and fiscal adjustment. “Already behind us.” Back”.

While there were “good reasons to worry” about a recession last year, he said, he “doesn’t see any particularly heightened risk right now.”

With the unemployment rate at historically low levels and millions of jobs still at stake, “it would be surprising if our labor market suddenly went into decline,” Mericle told CNN.

His team sees only a 15% chance of a recession in the next 12 months. They referred to this as the “unconditional historical average”, meaning that in any given year they believe there is a minimum 15% chance of a recession occurring. But when inflation peaked during the banking turmoil that began in March 2023, Goldman Sachs economists saw a 35% chance of a recession over the next 12 months.

He lowered his forecast from June as inflation continued to improve, the labor market became more balanced and banking tensions eased.

Although Mericle does not see any “obvious” trigger for a recession, he said it would likely be “some kind of unexpected shock to the economy.”

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