BofA joining the bears. It’ll be mild only if the Fed does not break something and it usually does. The other factor is the giant US inventory pile. Any destocking of size will turn a mild recession moderate.
Economic momentum has faded faster than expected
Our previous baseline outlook for the US economy featured a growth recession (e.g.,output growth remaining positive, but below our estimate of potential), but a number of forces have coincided to slow economic momentum more rapidly than we previously expected. Perhaps most worrisome to us is the trend in services spending, where revisions to prior data and incoming data, including from our BAC aggregated credit and debit card data, point to less momentum than we had been assuming.
Key headwinds include inflation and financial conditions
We think at least some of the decline in momentum in consumer spending is due to the“inflation tax.”With much of the recent rise in inflation coming from food and energy prices, commodities that face relatively inelastic demand in the short run, households may have less available for discretionary purchases. Financial conditions have also tightened, particularly in the mortgage market, where the spread of the 30y mortgage rate to the 10y US Treasury yield has risen sharply. The large run-up in home prices and higher mortgage rates have dented affordability, slowing home sales and housing starts.
No respite from Fed hikes this year
The Fed has communicated its desire to restore price stability and a willingness to accept at least some pain in labor markets in the process. We look for the Fed to raise the target range for the federal funds rate to 3.25-3.5% by year-end, including another 75bp hike at the upcoming July FOMC meeting.
We forecast a mild recession, starting in 2H 2022
We now forecast a mild recession in the US economy this year and expect 4Q/4Q real GDP in 2022 to decline 1.4%, followed by an increase of 1.0% in 2023. In terms of labor markets, the combination of a moderate downturn this year and below-trend growth for much of next year pushes the unemployment rate 1pp higher from 3.6% currently to 4.6%. With a sharper slowdown penciled in and higher unemployment, our outlook calls for inflation to moderate somewhat faster than before. We look for headline PCE inflation to move lower to 4.9% in 2022 (4Q/4Q) and 2.5% in 2023. The equivalent numbers for core PCE are 4.1% and 2.9%, respectively. Our forecast puts inflation broadly in line with the Fed’s 2% mandate by the end of 2024.
Risks are skewed towards a soft landing
We think the most likely alternative to our baseline outlook includes a US economy that avoids a near-term slowdown and requires a second round of tightening, perhaps in late2023 or into 2024. If we are wrong in our reading of incoming data, particularly about the strength in spending on services, then we have likely erred in the direction of underestimating current momentum. If so, then the recovery is likely to persist with GDP growth slowing only modestly, leaving the Fed with more work to do at a later date.