NEW YORK – A recession is now likely next year, most economists say. But so far that grim warning has been accompanied by this silver lining: Any downturn almost certainly will be mild.
In recent weeks, however, the odds of a more severe slump that would mean millions more job losses have been rising, they say.
Some economists blame a Federal Reserve that’s aggressively raising interest rates in a single-minded mission to tame stubbornly high inflation, even if it risks a recession.
“If the Fed keeps raising rates, it could cause more damage,” says Bob Schwartz, senior economist at Oxford Economics.
Economists also point to intensifying economic troubles in Europe, Chinese COVID-19 lockdowns that could escalate this winter, a sharp U.S. housing slowdown and even a U.S. job market that has been so resilient it’s prompting even bolder Fed action, among other factors.
Is there going to be a recession in 2022?
The most likely scenario is still a modest recession that lasts six to nine months or so. Eighty-eight percent of economists predict a downturn will be mild, according to a survey earlier this month by Wolters Kluwer Blue Chip Economic Indicators. But that’s down from 95% in October. That means the share of doomsayers has climbed to 12% from 5% within a few weeks.
What is a mild recession?
A mild recession could cost the economy 1.8 million jobs if the nation’s gross domestic product, or economic output, declines 1.2%, and the unemployment rate rises from a 50-year low of 3.5% to 5.4%, estimates Wells Fargo Chief Economist Jay Bryson.
That outcome would be roughly similar to recessions of the early 1990s and early 2000s and less severe than the average downturn in which GDP declines 1.6%, say Bryson and Joseph LaVorgna, chief economist of SMBC Capital Markets.
It also would be far less damaging than the Great Recession of 2007-09 (with its nearly 4% drop in output and 8.7 million job losses) and the COVID-19 recession of 2020 (with about a 10% drop in output and 22 million job losses).
What is a severe recession?
A severe recession could mean 3 million to 4 million job losses, a 2% to 2.5% decline in GDP and a 7% unemployment rate, Bryson says. Such a slump, he says, probably would last longer, perhaps a year or 15 months, as a virulent cycle takes hold, with widespread layoffs leading to less consumer spending, which would spur more layoffs.
Most economists are forecasting a mild slump because consumers and companies are in good shape financially and so have at least some wherewithal to keep spending even if the economy weakens and some people lose 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, according to the Federal Reserve.
Also, consumers still have nearly $2 trillion in pandemic-related savings, though that’s down from a peak of $2.6 trillion last year, according to Moody’s Analytics.
Meanwhile, the outstanding debt of nonfinancial corporations hit a record high of $12.5 trillion in the second quarter but it comprised just 3.7% of corporate profits, down from 4.8% in late 2019, according to the Fed and Oxford Economics. And despite sharply rising interest rates, many corporations refinanced their debt when rates were low, Bryson says. Seventy percent of it won’t reset to new rates for 12 months or longer.
Also, the economy isn’t beset by imbalances, as it was during the commercial real estate crisis of the early 1990s, the dot com meltdown of 2000 and the housing crash of the late 2000s, says Ian Shepherdson, chief economist of Pantheon Macroeconomics.
Still, several emerging forces could turn a mild recession into a severe one:
Even bigger Fed rate hikes
The Fed already has raised its key short-term interest rate from near zero to a range of 3% to 3.25% this year – its most aggressive campaign since 1980 – and has signaled it will push it up another 1.25 percentage points by the end of the year. Futures markets expect yet another half-point rise in early 2023, bringing it to a level designed to restrict economic growth.
The central bank repeatedly has ratcheted up the pace of the hikes despite growing recession risks, citing inflation that set a new 40-year high early this year and has since hovered just below that level.
If inflation continues to ease more slowly than anticipated, the Fed could bump rates even higher and keep them there even as the economy falters.
“If they raise rates to 5% and beyond, that could do real damage to the economy,” Schwartz says.
Fed rate increases already have clobbered the housing market with 30-year, fixed mortgage rates more than doubling to about 7% this year, and increasingly will dampen car purchases, credit card usage and business investment, Schwartz and LaVorgna say.
What’s more, LaVorgna says, the Fed for the first time is lifting rates even while the economy is sharply slowing.
“If they do what they say they’re going to do, we’re going to have a deep recession,” LaVorgna says, adding he believes Fed officials will reverse course before that happens.
Is the job market too strong?
Job openings have declined from a near-record 11.2 million in July to a still robust 10.1 million the following month. Because of persistent labor shortages, many companies are reluctant to lay off workers or sharply scale back hiring on fears they won’t be able to find employees when the economy bounces back.
Normally, a resilient job market helps cushion an economy against a recession. But now it likely will spur the Fed to continue to raise rates aggressively to temper wage gains that have helped fuel inflation. That could increase the risk of a deeper downturn “They’re trying to take steam out of the labor market without causing a recession,” Bryson says. “That’s a really tough thing to do.”
A Deutsche Bank study out this week says the Fed will need to raise its key rate enough to push unemployment near 6% to lower inflation close to its 2% target by the end of 2024.
Will housing prices go down in 2023?
Existing home sales fell for the eighth straight month in September. Home prices fell for the second straight month in August for the first time since 2011, according to the Federal Housing Finance Agency House Price Index.
Housing, mostly through new home construction, makes up just 4.6% of the economy, Schwartz says, adding he’s not worried about the sector contributing to a severe recession. Plus, the market looks nothing like it did in 2007, when banks doled out millions of subprime loans to unqualified borrowers, leading to massive foreclosures and layoffs.
But Gregory Daco, chief economist of EY-Parthenon, says housing wealth accounts for about half of total household net worth. He expects home prices to fall 6% by mid-2023.
“Rapidly falling prices could dampen household consumption and magnify the recessionary dynamics expected to grip the economy in 2023,” Daco wrote in a note to clients.
Could a deep recession in Europe ripple to U.S.?
Goldman Sachs now expects winter weather to trigger a more severe European downturn, one that’s being driven by soaring energy prices linked to Russia’s war with Ukraine.
S&P 500 companies generate about 14% of their revenue from sales in Europe, according to FactSet. Bryson worries a deeper downturn could further dent the outlook and investments of U.S. companies.
Could COVID in China impact U.S.?
Chinese cities are already imposing lockdowns to prevent the spread of COVID-19.
Bryson worries those efforts could intensify if a harsh winter triggers more cases, worsening supply chain bottlenecks for U.S. companies. Those snarls have eased, reducing product shortages and raising hopes for a drop-off in inflation.
Could corporate debt be a problem?
Although corporate debt levels are manageable, a slowing economy could hurt revenue growth, leaving companies with less cash to make payments, says Oren Klachkin, Oxford’s lead U.S. economist. S&P 500 earnings are projected to rise 1.5% for the third quarter, the slowest clip since 2020, FactSet says. That could further hammer business investment and cause U.S. banks to restrict lending even more.
“It’s a potential catalyst for more severe financial and economic stress,” Klachkin says.
What’s the risk of an unforeseen financial crisis?
Sharply rising interest rates can lead to crises that aren’t even on anyone’s radar, such as the implosion of the mortgage-related derivatives market in 2007, Schwartz says.
It could be a foreign country’s debt crisis as interest rates rise and a strong dollar makes repayment more challenging, or an overleveraged hedge fund, he says.
“It’s the unknown,” Bryson says.
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