As the recession approaches, some expect a higher intensity than expected

A recession is now likely next year, most economists say. But so far, this grim warning has been accompanied by this silver lining: Any dip will almost certainly be moderate.

But they say that in recent weeks, the odds of a more severe recession that would mean millions more job losses have risen.

Some economists blame the Federal Reserve which raised interest rates aggressively on a single-minded mission to tame stubbornly high inflation, even if it risks a recession.

“If the Fed continues to raise interest rates, it could cause more damage,” says Bob Schwartz, chief economist at Oxford Economics.

Economists also point to intensifying economic problems in Europe, Chinese COVID-19 lockdowns that could escalate this winter, a sharp housing slowdown in the US, and even a US labor market that has been so resilient that it prompted the Federal Reserve to take bolder action. , among other factors.

Will there be a recession in 2022?

The most likely scenario is a modest recession lasting six to nine months or so. Eighty-eight percent of economists expect the slowdown to be moderate, according to a survey earlier this month by Wolters Kluwer Blue Chip Economic Indicators. But this is down from 95% in October. This means that the share of the pessimists rose to 12% from 5% in a few weeks.

What is a moderate slack?

A mild recession could cost the economy 1.8 million jobs if the country’s gross domestic product, or economic output, falls 1.2% and the unemployment rate rises from a 50-year low of 3.5% to 5.4%, Wells Fargo chief economist Jay Bryson estimates. .

That outcome would be roughly similar to the recessions of the early 1990s and early 2000s and less severe than the average contraction in which GDP falls 1.6%, say Bryson and Joseph LaVorgna, chief economist at SMBC Capital Markets.

It would also be much less damaging than the Great Recession of 2007-2009 (with production down around 4% and 8.7 million jobs lost) and the COVID-19 recession of 2020 (with about a 10% drop in production, 22 million job losses).

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What is a severe recession?

A severe recession could lead to the loss of 3 to 4 million jobs, a Bryson says a 2% to 2.5% drop in GDP, and a 7% unemployment rate.

He says such a recession could last longer, perhaps a year or 15 months, as the virulent cycle continues, with widespread layoffs leading to less consumer spending, which could lead to more layoffs.

Most economists expect a mild recession because consumers and businesses are in good financial shape, and so they have at least some money to keep spending even if the economy weakens and some people lose their jobs.. Home debt was 9.6% of disposable personal income in the second quarter, up from 8.4% early last year but well below a peak of 13.2% 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, although that’s down from a peak of $2.6 trillion last year, according to Moody’s analytics.

Meanwhile, debt owed to nonfinancial companies hit a record $12.5 trillion in the second quarter, but made up just 3.7% of corporate profits, down from 4.8% in late 2019, according to the Federal Reserve and Oxford Economics. Despite the sharp rise in interest rates, many companies refinanced their debt when interest rates were low, Bryson says. Seventy percent of it will not be reset to new rates for 12 months or more.

Also, the economy doesn’t suffer from imbalances, as it was during the commercial real estate crisis in the early 1990s, the internet crash of 2000, and the housing crash in the late 2000s, says Ian Shepherdson, chief economist at the Macroeconomic Pantheon.

However, several emerging forces can turn a mild recession into a severe one:

Even bigger Fed rate hike

The Fed has already raised its key short-term rate from nearly zero to a range of 3% to 3.25% this year – its most aggressive campaign since 1980 – and has indicated it will raise it by another 1.25 percentage points by the end of the year. Futures markets anticipate another half-point rally in early 2023, bringing it to a level designed to constrain economic growth.

The central bank has repeatedly ramped up the pace of increases despite rising recession risks, citing inflation that set a new 40-year high early this year and has since been hovering below that level.

If inflation continues to fall more slowly than expected, the Fed may raise rates even higher and keep them there even as the economy falters.

“If they raise rates to 5% and more, it could do real damage to the economy,” Schwartz says.

Schwartz and LaVorgna said increases in federal rates have already hurt the housing market, with 30-year fixed mortgage rates more than doubled to about 7% this year, and will increasingly dampen car purchases, credit card use and business investment. .

What’s more, says LaVorgna, the Fed is for the first time raising interest rates even as the economy slows sharply.

“If they do what they say they will do, we will have a deep recession,” LaVorgna says, adding that he believes Fed officials will reverse course before that happens.

Is the job market too strong?

Job vacancies have fallen from nearly 11.2 million in July to a still solid level 10.1 million in the following month. Due to the persistent shortage of labor, many companies are reluctant to lay off workers or sharply reduce hiring due to concerns that they will not be able to find employees when the economy recovers.

Usually, a flexible labor market helps protect the economy from recession. But it is now likely that the Fed will incentivize to continue aggressively raising interest rates to quell wage gains that have helped fuel inflation. This can increase the risk of a deeper contraction

“They are trying to force the labor market out without causing a recession,” Bryson says. “This is really difficult.”

A Deutsche Bank study this week says the Federal Reserve will need to raise its key rate enough to push the unemployment rate close to 6% to bring inflation close to its 2% target by the end of 2024.

Will home prices fall in 2023?

Existing home sales declined for the eighth consecutive month in September. Home prices fell for the second straight month in August for the first time since 2011, according to the Home Price Index from the Federal Housing Finance Agency.

Housing, mostly through new home construction, makes up only 4.6% of the economy, Schwartz says, adding that he is not concerned about the sector’s contribution to a severe recession. Plus, the market doesn’t look what it did in 2007, when banks made millions of subprime mortgages to unqualified borrowers, leading to foreclosures and layoffs.

But Gregory Daco, chief economist at EY-Parthenon, says housing wealth accounts for about half of total household net wealth. He expects home prices to rise by 6% by mid-2023.

“Rapidly declining prices could weaken household consumption and amplify the recessionary dynamics expected to dominate the economy in 2023,” Dako wrote in a note to clients.

Could a deep recession in Europe spread to the United States?

Goldman Sachs now expects winter weather to lead to a sharper European slowdown, driven by higher 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 fears that a deeper recession could affect the outlook and investment of US companies.

Could the Corona virus in China affect the United States?

Chinese cities are already imposing lockdowns to prevent the spread of COVID-19. Bryson worries that those efforts could intensify if a harsh winter causes more cases, exacerbating supply chain bottlenecks for US companies. These crises have eased, reducing product shortages and raising hopes of a drop in inflation. .

Could corporate debt be a problem?

Although corporate debt levels are manageable, a slowing economy can hurt revenue growth, leaving companies with less cash to make payments, says Oren Kalashkin, chief US economist at Oxford. S&P 500 earnings are expected to rise 1.5% for the third quarter, the slowest segment since 2020, says FactSet.

This could further slow business investment and prompt US banks to restrict lending even more.

“It’s a potential catalyst for more severe financial and economic pressures,” Kalashkin says.

What are the risks of an unexpected financial crisis?

A sharp rise in interest rates could lead to crises that aren’t even on anyone’s radar, says Schwartz, like the 2007 mortgage-related derivatives market crash.

It could be a foreign country’s debt crisis with rising interest rates and a strong dollar making repayment more difficult, or an over-indebted hedge fund, he says.

“It’s the unknown,” Bryson says.