America avoids a recession. What can go wrong?

With inflation falling, unemployment falling and the Federal Reserve signaling it may soon start cutting interest rates, forecasters are increasingly optimistic that the US economy can avoid recession.

Wells Fargo last week became the latest big bank to predict the economy would reach a soft landing. The bank's economists forecast a recession from mid-2022.

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

Indeed, on the same day that Wells Fargo reversed its recession call, its economists also issued a report pointing to signs of weakness in the labor market. Hiring has slowed, and only a handful of industries account for recent job gains. Layoffs are low, but workers who lose jobs are struggling to find new ones.

“We're not out of the woods yet,” said Sarah House, author of the report. “We still think recession risk is still high.”

Ms House and other economists insist there are good reasons for their recent optimism. The economy faced a faster rise in interest rates than most forecasters expected. A surprisingly fast slowdown in inflation has given policymakers more leeway — for example, if unemployment starts to rise — the central bank could cut rates to prolong the recovery.

Economists say that if a recession comes, three main ways can happen:

The main reason economists predicted a recession last year was because they expected the Fed to trigger a recession.

Central bank officials have spent the past two years trying to control inflation by raising interest rates at their fastest pace in decades. The goal was to reduce demand enough to reduce inflation, but not so much that companies would start widespread layoffs. Most forecasters — including many at the Fed — thought such careful calibration would be too tricky and that once consumers and businesses began to pull back, a recession was inevitable.

See also  Vatican: Pope OK to leave hospital, eat pizza, baptize baby

It is still possible that their analysis was correct and only the timing was wrong. The effects of higher interest rates take time to flow through the economy, and there are reasons why this system may be slower than usual.

For example, many companies refinanced their debt in 2020 and 2021 during extremely low interest rates; They will realize higher borrowing costs only when they need to refinance again. Many families were able to avoid higher rates because they had built up savings or paid off loans ahead of the pandemic.

However, those buffers are eroding. Additional savings are declining or already gone, according to most estimates, and credit card borrowing is setting records. High mortgage rates have slowed the housing market. Student loan payments that were suspended for years during the pandemic have resumed. State and local governments are slashing their budgets as federal aid dries up and tax revenues drop.

“When you look at all the supports that consumers have had, a lot of them are disappearing,” said Dana M. Peterson said.

The manufacturing and housing sectors have already experienced a slowdown, with manufacturing contracting, Ms. And business investment has lagged far behind, Peterson said. Consumers are the final pillar that sustains the recovery. If the job market weakens even a little bit, “it will wake people up and think, 'Well, I might not get fired, but I might get laid off, and at least I'm not going to get that big. Bonus,'” and cut their spending accordingly.

The biggest reason economists are more optimistic about the possibility of a soft landing is the rapid cooling of inflation. Thanks to some short-term measures, inflation is now above the central bank's long-term target of 2 percent; The prices of some physical goods, such as furniture and used cars, are actually falling.

See also  Arsenal came from 2-0 down to beat Bournemouth in the last minute

If inflation is under control, it gives policymakers more room for maneuver, for example, allowing them to lower interest rates if unemployment starts to rise. Already, federal officials have indicated they will begin cutting rates sometime this year.

But if inflation picks up again and the economy loses momentum, policymakers could find themselves in a tight spot, unable to cut rates. Or worse, they may be forced to consider raising rates again.

“Despite strong demand, we still have low inflation,” 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 Reserve Bank of India. “The question now is, going forward, are we going to be very lucky?”

Inflation eased in 2023 as 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 rebounded and Americans returned to the job market. This means that firms can obtain the necessary materials and labor to meet demand without raising prices.

However, few expect a similar supply revival in 2024. This means that for inflation to continue to fall, demand must fall. This may be especially true in the service sector, where prices are more tightly tied to wages – and where wage growth is relatively strong due to demand for workers.

Financial markets can make the central bank's job more difficult. Stock and bond markets both rallied late last year, which could effectively nullify some of the central bank's efforts by making investors feel richer and allowing corporations to borrow more cheaply. This may help the economy in the short term, but forces the central bank to act more aggressively, raising the risk of a recession down the road.

“If we don't maintain tight enough monetary conditions, there is a risk that inflation will pick up again and reverse the progress we've made,” Dallas Federal Reserve Bank President Lori K. Logan warned this month. In a text At the annual conference for economists in San Antonio. As a result, the central bank should leave open the possibility of another hike in interest rates, he said.

See also  Trump lawyers met with a special counsel at the Justice Department amid the documents hearing

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

There is no guarantee that the luck will continue in 2024. Expanding war in the Middle East disrupts shipping lanes in the Red Sea. Congress faces another government-funding deadline in March after passing a stopgap spending bill on Thursday. And new threats may emerge: a more deadly strain of the coronavirus, a conflict in the Taiwan Strait, a crisis in some previously obscure corner of the financial system.

Either of those possibilities could destabilize the equilibrium by causing a spike in inflation or a decline in demand — or both trying to strike at the same time.

“If you're a central banker, that's the thing that keeps you up at night,” said Karen Tynan, a Harvard economist and former Treasury Department official.

While such risks are always present, the Fed has very little margin for error. The economy has slowed significantly and, if there is an impact on growth, is little more than a buffer. But with inflation still high — and memories of hyperinflation still fresh — the central bank will find it hard to ignore even a temporary price hike.

“A mistake on either side would create job losses,” Ms Tynan said. “Risks are more balanced than they were a year ago, but I don't think that should provide much comfort to decision makers.”

Audio produced Patricia Sulbaran.

Leave a Reply

Your email address will not be published. Required fields are marked *