The Recession Predictions Begin

Yesterday, Deutsche Bank became the first major bank to forecast a recession in 2023. Economists David Folkerts-Landau and Peter Hooper predicted that the Fed’s raising interest rates to control inflation will cause a recession next year and bump the unemployment rate up to 4.9 percent in 2024 (it’s at 3.6 percent currently). “Our call for a recession in the U.S. next year is currently way out of consensus,” they wrote. “We expect it will not be so for long.”

A Bloomberg survey of financial professionals and investors indicates that the view is becoming more widespread. Only 15 percent predict a recession this year, but 48 percent predict one next year. They are concerned mostly about the inversion in the yield curve for two-year versus ten-year Treasury bonds, which means the two-year bond has a higher yield than the ten-year bond. A yield-curve inversion has come before every recent recession (although the exact causal connection between the two isn’t totally clear).

Larry Summers took to the pages of the Washington Post yesterday to give his prognosis, which is similarly negative:

There is a first time for everything, but over the past 75 years, every time inflation has exceeded 4 percent and unemployment has been below 5 percent, the U.S. economy has gone into recession within two years. Today, inflation is north of 6 percent and unemployment is south of 4 percent.

He sees the Fed as “dangerously behind the curve” (a view that Scott Sumner shares). Summers is not convinced that inflation will return to an acceptable level largely on its own, which seems to be the Fed’s view based on its forecasts and projected rate hikes that are relatively modest by historical standards. He writes that “there can be no real question but that the American job market is unsustainably hot and in need of restraint” and that this hot job market is raising demand and prices.

This is nothing new for Summers, of course. He’s been sounding the alarm on economic policy since last year. As Andrew Stuttaford cleverly wrote in January, “It’s Summers time, and the livin’ won’t be easy.”

Even the perpetually sunny and optimistic James Pethokoukis wrote he is “thinking (worrying, actually) about the chances of a US recession.” In an AEI blog post from last week, Pethokoukis said:

Again, the concern was that sustained inflation would create a higher risk of recession. And how do things stand now? One can certainly point to a variety of market indicators, including the yield curve — suggesting increased recession risk. One of the clearer narratives about how it all might go down has been supplied by William Dudley, former president of the New York Fed. In a new Bloomberg column, Dudley takes issue with the notion that we should take some comfort from past successful Fed efforts to engineer a soft landing — to raise interest rates and lower inflation without pushing up unemployment.

Dudley sees a recession as inevitable. In his column, he argues that the Fed is so far behind the curve on inflation that it will not be possible to get it back under control without causing a recession. (I speculated on this possibility in early October.) “The Fed has never achieved a soft landing when it has had to push up unemployment significantly,” Dudley writes, and unemployment is currently much lower and inflation much higher than in past recession-less episodes of monetary tightening.

In the past few weeks, the gloom has become more widespread on the prospects of a recession in the near future. How severe it might be if it does occur is an entirely separate question. It’s certainly possible that a brief, mild recession could snap inflation back on track with only temporary damage to the extremely hot labor market. But there’s no way to know anything about future recessions with any certainty, and things could just as easily become much worse.

Take all recession predictions with a grain of salt, and read them carefully to understand the reasoning behind them. Economic forecasters are wrong a lot, as we all know. The shift in expectations in the past week or two has been noticeable, though. Deutsche Bank’s outlier projection among major banks could be a mistake — or it could be a leading indicator.