In a day of drama at the Federal Reserve, Wall Street appears to have overlooked one thing: The central bank foresees a recession this year.
The Fed on Wednesday raised a key U.S. interest rate, but also signaled just one more rate hike to come as it wages a war on high inflation.
Chairman Jerome Powell admitted the financial sector stress spawned by the failure of Silicon Valley Bank forced the Fed to adopt a less aggressive monetary policy posture, even as he insisted the U.S. banking system is “sound.” Before the SVB fallout, the Fed planned to raise rates even higher.
Less noticed was the bank’s forecast for economic growth in 2023. The Fed downgraded its estimate of gross domestic product to 0.4% from 0.5%. GDP is the official scorecard for the economy.
No big deal, right? Well, it actually sort of is. Here’s why.
When the Fed issued its 2023 forecast in December, most Wall Street economists expected GDP to be flat or even negative in the first quarter. Economists at America’s top banks, for example, saw zero growth.
Yet the economy has grown more strongly early in the year than the Fed or most economists predicted. GDP could grow as much as 3% from January through March, according to some estimates.
If that’s the case, GDP would have to start to slow sharply soon and turn negative later in the year to end up close to the Fed’s new 0.4% target. Most likely GDP would be negative for at least a few quarters.
In other words, a recession.
“They didn’t explicitly come out and call for a recession,” said senior economist Sam Bullard at Wells Fargo in Charlotte, N.C. “But it does appear the Fed’s updated forecast appears to suggest a material deceleration in economic growth.”
A period of prolonged softness in the economy is what Fed officials think they need cool off high inflation. Prices pressures would likely ease considerably if demand for labor, goods and services went slack.
Workers would be less willing to ask for higher pay or switch jobs, for example, if layoffs rose and they felt less secure. And companies would have to slow or even reverse price increases to try to drum up faltering sales as the economy weakened.
Yet the implicit forecast of a recession has to be treated with caution given the Fed’s especially poor track record on economic forecasts over the past few years.
The central bank failed to spot the surge in inflation in 2021 and 2022, for instance, and even now prices are not falling as quickly as the Fed expected.
Wall Street
DJIA,
SPX,
itself is also split.
A slim majority of economist appear to expect a recession this year. Some even contend a recession would be longer and deeper than the Fed’s forecast seems to suggest.
Yet others are unwilling to go that far and think the economy could continue to muddle along, albeit at a very slow pace.
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