S&P Global Chief Economist says balance of risks is clearly on the downside with recession probabilities rising, especially in the U.S.
Aggressive Federal Reserve policy spurred by ongoing price spikes will usher in low economic growth this year and perhaps a recession next year, which could push the central bank to reconsider guidance suggesting it will push rates further toward 4% in 2023, Global Chief Economist at S&P Global Ratings Paul Gruenwald told MNI.
In the Fed's projections released in June, the median central bank official penciled in a 3.4% fed funds rate by year-end and a terminal rate of 3.8% in 2023. Yet 2023 is when many economists, including Gruenwald, believe the economy might slip into recession as unemployment ticks up and consumer spending ebbs.
"The Fed is strongly focusing on the inflation numbers, and inflation expectations moving higher supports the Fed's overshoot argument, but maybe they'll need to slow down if there is a turn later on in consumption," he said.
"If inflation trends hold up, the Fed's got another 75 in the bag [in July] and then they're gonna see what happens, but the Fed is likely to peak out in 2023," Gruenwald added. "The recession risk is probably a bit earlier in 2023 relative to that peak and so it could be a bit awkward in the sense that the Fed is still seeing inflation pressure but the economy is slowing quickly and then there's a difficult judgment call."
Fed Chair Jerome Powell has ramped up commitments to raise rates, promising an "unconditional" fight to combat high prices, but has shown some uncertainty as to whether it will be necessary for the Fed to reach the range of 3.5-4% next year. New York Fed President John Williams told CNBC this week: "The thing that I have greater certainty about is we definitely need to get the funds rate up to between 3 and 3.5% by later this year."
While U.S. economic momentum will likely forestall a recession in 2022, the weight of high prices damaging consumer purchasing power, together with an aggressive Fed, make it difficult to see the American economy walking out of 2023 unscathed, Gruenwald said.
"A growth slowdown is inevitable, but the key question is whether we have a more serious recession," he said. "We seem to have leveled off, but we have been slipping on the growth rate over the last few quarters."
"If things start to slow down, and if the job market starts to go south and savings cushions start to wear out, that's when we get into the bad scenario," he said. "Consumption probably won't slow too much in 2022 but the danger is more in 2023."
S&P has downgraded forecasts for U.S. GDP, seeing growth at an annual rate of 2.4% this year and 1.6% next year, with the unemployment rate rising from 3.6% to 4.3% by year-end and to 4.6% by the end of 2024, above the Fed's 4.1% forecast. S&P is putting the odds of a recession in 2023 at 40%. Fed economists have told MNI they see little sign of a coming recession. (See: MNI INTERVIEW: US Inflation Has Likely Peaked-Fed’s Andolfatto)
Asked whether there is a speed at which the economy stalls, Gruenwald said falling asset prices, increasing borrowing costs and a stronger exchange rate are all tightening financial conditions. "When those factors come together with negative labor market momentum then that is a pretty good sign that we're going into a more serious downturn."