Home Economy The United States appears to be dodging a recession. What can go wrong?

The United States appears to be dodging a recession. What can go wrong?

by SuperiorInvest

With inflation falling, unemployment low and the Federal Reserve signaling that it could soon begin cutting interest rates, forecasters are becoming increasingly optimistic that the U.S. economy could avoid a recession.

Last week, Wells Fargo became the latest major bank to predict that the economy will achieve a soft landing, slowing gently rather than coming to a screeching halt. The bank’s economists predicted a recession from mid-2022.

However, if forecasters were wrong when they predicted a recession last year, they could be wrong again, this time in the opposite direction. The risks that economists highlighted in 2023 have not gone away, and recent economic data, while still mostly positive, has suggested some cracks beneath the surface.

In fact, on the same day Wells Fargo reversed its recession forecast, its economists also released a report pointing to signs of weakness in the labor market. Hiring has slowed, they noted, with only a handful of industries accounting for much of the recent job gains. Layoffs remain low, but workers who lose their jobs have a harder time finding a new one.

“We’re not out of the woods yet,” said Sarah House, the report’s author. “We continue to believe that the risk of recession remains high.”

House and other economists have stressed that there are good reasons for their recent optimism. The economy has weathered the rapid rise in interest rates much better than most forecasters expected. And the surprisingly rapid slowdown in inflation has given policymakers more room to maneuver: If unemployment starts to rise, for example, the Federal Reserve could cut rates to try to prolong the recovery.

If a recession hits, economists say there are three main ways it could happen:

The main reason economists predicted a recession last year is that they expected the Federal Reserve to cause it.

Federal Reserve officials spent the past two years trying to control inflation by raising interest rates at the fastest pace in decades. The goal was to reduce demand enough to reduce inflation, but not so much that companies began widespread layoffs. Most forecasters – including many within the central bank – thought that such careful calibration would prove too complicated and that once consumers and businesses began to retreat, recession was almost inevitable.

It is still possible that his analysis was correct and that just the timing was wrong. It takes time for the effects of higher interest rates to flow through the economy, and there are reasons why the process may be slower than usual this time.

Many companies, for example, refinanced their debt during the period of ultra-low interest rates in 2020 and 2021; Only when they need to refinance again will they feel the impact of higher borrowing costs. Many families were able to ignore higher rates because they had built up savings or paid off debt early in the pandemic.

However, those reserves are eroding. Extra savings are declining or have already dried up, by most estimates, and credit card debt is setting records. Higher mortgage rates have slowed the housing market. Student loan payments, which were suspended for years during the pandemic, have resumed. State and local governments are cutting their budgets as federal aid dries up and tax revenues fall.

“When you look at all the support consumers have had, a lot of it is fading,” said Dana M. Peterson, chief economist at the Conference Board.

The manufacturing and real estate sectors have already experienced recessions, with output contracting, Peterson said, and business investment is lagging more broadly. Consumers are the last pillar supporting the recovery. If the job market weakens even a little, he added, “that might wake people up and make them think, ‘Well, I might not get fired, but I might get fired, and at least I’m not going to get as much money.'” “. bonus” and reduce your expenses accordingly.

The main reason economists have become more optimistic about the possibility of a soft landing is the rapid cooling of inflation. By some shorter-term measures, inflation is now just above the Federal Reserve’s long-term goal of 2 percent; Prices of some physical goods, such as furniture and used cars, are actually falling.

If inflation is under control, that gives authorities more room to maneuver, allowing them to cut interest rates if unemployment starts to rise, for example. Federal Reserve officials have already indicated they hope to start cutting rates sometime this year to keep the recovery on track.

But if inflation picks up again, authorities could find themselves in a difficult situation, unable to cut rates if the economy loses momentum. Or worse, they could even be forced to consider raising rates again.

“Despite strong demand, inflation has still come down,” said Raghuram Rajan, an economist at the University of Chicago Booth School of Business who has held senior positions at the International Monetary Fund and the Bank of India. “The question now is: will we be as lucky in the future?”

Inflation fell in 2023 in part because the supply side of the economy improved significantly: supply chains largely returned to normal after disruptions caused by the pandemic. The economy also received an influx of workers as immigration picked up and Americans returned to the labor market. That meant companies could get the materials and labor they needed to meet demand without raising prices as much.

However, few people expect a similar resurgence in supply in 2024. That means that for inflation to continue falling, a slowdown in demand may be necessary. This could be especially true in the services sector, where prices tend to be more closely tied to wages and where wage growth has remained relatively strong due to demand for workers.

Financial markets could also be making the Federal Reserve’s job more difficult. Stock and bond markets rallied late last year, which could effectively undo some of the Federal Reserve’s efforts by making investors feel richer and allowing corporations to borrow more cheaply. That could help the economy in the short term, but it would force the Federal Reserve to act more aggressively, increasing the risk of causing a recession in the future.

“If we do not maintain sufficiently tight financial conditions, there is a risk that inflation will rebound and reverse the progress we have made,” Lorie K. Logan, president of the Federal Reserve Bank of Dallas, warned this month. in a speech at an annual conference of economists in San Antonio. As a result, she said, the Federal Reserve should leave open the possibility of another interest rate increase.

The economy had some lucky breaks last year. China’s weak recovery helped keep commodity prices in check, contributing to the slowdown in US inflation. Congress averted a government shutdown and resolved a standoff over the debt ceiling with relatively little drama. The outbreak of war in the Middle East had only a modest effect on world oil prices.

There is no guarantee that luck will continue in 2024. The widening war in the Middle East is disrupting shipping lanes in the Red Sea. Congress will face another government funding deadline in March after passing a stopgap spending bill on Thursday. And new threats could emerge: a deadlier strain of coronavirus, a conflict in the Taiwan Strait, a crisis in some previously dark corner of the financial system.

Either of those possibilities could upset the balance the Fed is trying to achieve by causing a rise in inflation or a collapse in demand, or both.

“That’s what, if you’re a central banker, keeps you up at night,” said Karen Dynan, a Harvard economist and former Treasury Department official.

Although those risks always exist, the Federal Reserve has little room for error. The economy has slowed significantly, leaving less cushion in case growth is hit again. But with inflation still high — and memories of high inflation still fresh — the Federal Reserve could find it difficult to ignore even a temporary rise in prices.

“There is room for error on both sides that would end up leading to job losses,” Ms. Dynan said. “The risks are certainly more balanced than they were a year ago, but I don’t think that provides much more comfort to decision makers.”

Audio produced by Patricia Sulbarán.

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