Daily Management Review

Fed And Experts Revise Their Forecasts For A US Recession


Fed And Experts Revise Their Forecasts For A US Recession
A year ago, a sizable portion of the U.S. believed the nation was in, or would soon enter, a recession. You can blame this belief on the disconnect between economic theory and reality, forecaster herd mentality, or political partisanship on the side of the Biden administration's detractors.
The production of the American economy shrank in the first two quarters of 2022 at annual rates of 0.6% from April through June and 1.6% from January through March. According to one popular definition, which isn't technically correct, the nation had already experienced a downturn.
Why not, you ask? The Federal Reserve was rapidly raising interest rates, home investment appeared to be faltering, and common wisdom predicted further declines in other sectors of the economy, consumer spending, and the employment market.
"A number of forces have coincided to slow economic momentum more rapidly than we previously expected," Michael Gapen, chief U.S. economist at Bank of America, said in a July 2022 analysis. "We now forecast a mild recession in the U.S. economy this year ... In addition to fading of prior fiscal support ... inflation shocks have eaten into real spending power of households more forcefully than we forecasted previously and financial conditions have tightened noticeably as the Fed shifted its tone toward more rapid increases in its policy rate."
After a year, the unemployment rate, which was 3.5% in July, is actually lower than the point at which many analysts anticipated it to start increasing, consumers are still spending, and many expert economic forecasts have corrected their path in line with Gapen.
The likelihood of a recession one year from now increased from 25% in April 2022, the month following the first rate hike of the Fed's current tightening cycle, to 65% in October, according to surveys of economists conducted by Reuters during the previous year. 55% is the most recent reading.
"Incoming data has made us reassess our prior view" of a coming recession that had already been pushed into 2024, Gapen wrote earlier this month. "We revise our outlook in favor of a 'soft landing' where growth falls below trend in 2024, but remains positive throughout."
Recession revisionists include the Fed's own staff, who used their models to gradually downgrade the outlook for the U.S. They started by becoming more concerned about "downside risk" in the autumn of 2018, moved to citing recession as a "plausible" outcome in the winter of 2019, and then predicted that a recession would start this year as of the Fed's March 2023 meeting.
According to the minutes of the Fed's March 21–22 meeting, "the staff's projection... included a mild recession starting later this year, with a recovery over the subsequent two years," with the failure of California's Silicon Valley Bank projected to place an additional restriction on bank credit.
The Fed staff's forecasts "continued to assume" that the U.S. economy would be in a recession by the end of the year in May and June.
The more pessimistic perspective vanished at the meeting on July 25–26, according to recently made public minutes.
"The staff no longer judged that the economy would enter a mild recession toward the end of the year," the minutes said, though the staff still felt the economy would slow to a growth rate below its long-run potential in 2024 and 2025, with inflation falling and risks "tilted to the downside."
The quarterly predictions made by Fed policymakers, which are separate from the staff assessment, have never indicated an annual decline in GDP.
What distinguished growth that has pleasantly surprised from an impending recession that many believed was under way last year?
The forecast was not even close to being accurate: Growth quickly recovered to a 3.2% annual pace by the third quarter of last year, and it has since sustained itself at 2% or higher, exceeding the 1.8% that the Fed views as the economy's underlying potential. An alarming 5.8% "nowcast" for GDP growth from the Atlanta Fed for the current period of July to September indicates that consumer spending is still gaining strength and that industrial production and housing starts have unexpectedly rebounded.
The tenacity of American consumers, who, in the words of Omair Sharif, president of Inflation Insights, have kept "chugging along" and spending more than anticipated, is a significant factor in the story.
Spending has changed from the goods-gorging purchases observed at the beginning of the coronavirus pandemic to the booming services economy this summer, which resulted in billion-dollar box office returns and music festivals.
But regardless of what is in the basket, the dollar amounts continue to rise, leading economists to either gradually postpone the time when the "excess savings" of the pandemic era will run out or to wonder whether low unemployment, ongoing strong hiring, labour "hoarding" by businesses, along with rising earnings, have overcome any concerns about the future.
But it goes beyond that.
In an economy where consumers spend more on services that are less sensitive to interest rates and where businesses have continued to borrow and invest more than many economists anticipated, perhaps to take advantage of regulatory changes intended to promote technology and green energy projects, it may not be the case that high interest rates have the same effects.
As communities put monies from the pandemic era to work on a delayed basis, an increase in local government spending also provided an unanticipated boost to growth.
Can it endure?
One possibility is that the economy becomes tighter than anticipated combined with a resurgent inflation, forcing the Fed to tighten policy even further and triggering the inflation-killing slump that authorities are still hoping to avoid.
However, those chances might be dwindling.
"We've been wavering for a while on whether to shift to the 'soft-landing' camp, but no longer," noted Sal Guatieri, a senior economist at BMO Capital Markets, in reference to the Fed's hopes of lowering inflation without provoking a recession.
"Broad strength" in the U.S. economy, he said, "convinced us that the U.S. economy is more durable than expected ... Not only is it not slowing further, it might be picking up."