- A growing number of experts see a recession on the horizon, but the economic community is split.
- Fed chair Jerome Powell believes the US can still cool inflation without sparking a downturn.
- Others fear the war in Ukraine and late Fed action have doomed the US to a new crisis.
The US economy hasn't fully healed from the coronavirus recession, yet there's a growing argument over whether the country is barreling into a new downturn.
It all comes down to inflation, specifically the Federal Reserve's plan to fight it. The central bank started ratcheting up its benchmark interest rate in March and is largely expected to raise rates at every one of its six meetings left in 2022. The hikes aim to soften Americans' spending and more closely match demand with strained supply. If all goes according to plan, the Fed's policymakers see inflation starting to fall later in 2022 and reaching more palatable levels by the end of next year.
Such a feat is known among economists as a "soft landing," in which inflation eases and unemployment remains low. If achieved, a soft landing would leave the economy in a much more robust position as it enters a new expansionary cycle. That's what Jerome Powell, the chair of the Federal Reserve, aims to do, and officials have so far expressed confidence in those efforts.
Many economists aren't convinced. Many view the soft-landing goal as a pipe dream, arguing the central bank waited too long to start cooling the hottest inflation in four decades. Some have even forecast a recession before the end of the year, as they see the Fed slowing the economy so much it starts to shrink. Such an event would see the US suffer a massive jump in unemployment, a slowdown in economic activity, and multiple quarters of shrinking output.
The divide underscores just how much uncertainty remains in the pandemic-era rebound, as well as a split in how Americans regard its progress. While some point to the rapid recovery of jobs as an encouraging sign, others see the labor shortage as a serious obstacle. Some economists cheer the boom in retail spending, yet just as many others highlight the fact that Americans' sentiments are the bleakest they've been in nearly 11 years.
The jury is still out on whether a recession is on the horizon. But as the Russian war in Ukraine stokes new inflation fears and the recovery charges forward, each side of the argument is getting louder.
In one corner, economists fear overcorrection will spark a crisis
Hawkish economists predicting a recession in the coming months are pointing to two drivers: the Fed's timing and the Russian invasion of Ukraine. The former is seen as a policy mistake that's allowed inflation to run extremely hot for far too long. The latter is regarded as the spark that will light a recession by lifting inflation to even more concerning levels.
The conflict has already boosted prices across the board. The prices of key energy commodities like natural gas and crude oil have surged in recent weeks. Wheat costs have similarly ballooned, as have prices for commercial fertilizers critical to keeping crop yields strong. Manufacturing goods like nickel and neon have also seen prices soar, risking yet another supply-chain nightmare for durable goods like cars and electronics.
The inflationary impact has been large enough for some major banks to pencil in a downturn. Deutsche Bank is the latest to do so, saying in a Tuesday note that the Fed finds itself "well behind the curve" in cooling price growth.
"The war, which has transitioned into a stalemate that is unlikely to be resolved any time soon, has disrupted activity on a number of fronts," the team led by David Folkerts-Landau, said in a note, adding they expect a recession in the US and euro area "within the next two years."
Those predicting a recession see rates getting so high they actually reverse economic growth as Americans rein in their spending and starve the economy of its key fuel.
One of the loudest voices forecasting a downturn has been former Treasury secretary Larry Summers. The economist projected a "major recession" in a recent Washington Post column, saying the Fed "has not internalized the magnitude of its errors over the past year." For the central bank to avoid a downturn and loss of public confidence, it will need to "head in a dramatically different direction," Summers said.
Even some former Fed officials don't think the central bank can pull it off without inducing a recession. The Fed simply didn't act fast enough to pull inflation lower, and a "hard landing" is now "virtually inevitable," Bill Dudley, a Bloomberg opinion columnist and former president of the New York Fed, said in a March 29 column.
"Powell blames bad luck — surprises such as snarled supply chains that officials could not have anticipated," Dudley said. "To some extent he might be right, but the Fed nonetheless bears responsibility for being so slow to recognize the inflation risks and begin to tighten policy."
In the other, experts see the Fed nailing a 'soft landing'
Powell rebutted recession concerns in a March 16 press conference as fears of a new downturn emerged. The central bank's timing allowed for economic activity to quickly recover over the past two years, and the country is now in a healthy enough spot to stomach higher borrowing costs, Powell said.
"The probability of a recession within the next year is not particularly elevated," the chair said. "All signs are that this is a strong economy, one that will be able to flourish — not to say withstand, but certainly flourish — in the face of less accommodative monetary policy."
Much of that strength comes from the labor market's V-shaped rebound. Unlike the recovery after the 2008 financial crisis, the US swiftly recouped most of the jobs it lost at the onset of the recession. In just 25 months, the country has added back 93% of all lost payrolls. By comparison, the post-financial crisis economy took 25 months to reach its lowest point.
Other measures suggest that strength extends beyond the hiring recovery. While spending growth slowed in February, overall consumer spending hit a record annualized rate of $16.7 trillion that month. Saving is also well above the pre-pandemic trend, suggesting Americans are exiting the coronavirus recession with significant financial strength.
Household savings are also in a good spot despite elevated inflation. Americans collectively hold about $2.5 trillion in excess savings built up during the pandemic, Bloomberg economists estimated in March. Only about 27% of that stash will go toward paying higher costs associated with inflation. Households can still post "a solid increase in aggregate spending" through 2022, the economists said, adding that much of the bolstered savings sit with the bottom 80% of earners, a cohort that spends more of their saved dollars than wealthy Americans.
The Fed, then, could be timing its policy pullback just right. While Americans feel badly about the economy, they're still spending big and have boosted savings to draw from. Demand for workers is also at historic levels. Higher rates will dampen the speed of the recovery, but if Powell is right, the Fed is on its way to engineering an extraordinary soft landing considering the circumstances.