For more than a year, economists have been waiting for the recession to hit, but it continues to confront them and may be stopped altogether.
The resilience of the labor market has boosted the hopes of economists who believe the Fed can cool inflation while avoiding massive job cuts, a scenario Fed officials call a “soft landing.” The Fed’s favorite measure of inflation, personal consumer spending, fell from its peak of a 7% annual increase to 4.4% despite a hike in April, more than halfway to the Fed’s 2% inflation target. Meanwhile, the unemployment rate fell to 3.4% in April, its lowest level since 1969.
Past downturns, such as the Great Recession, have involved business failures, mass layoffs, wealth destruction, and economic misery affecting millions. All this has been avoided, at least so far, as the economy has resisted all the powerful forces pulling it down.
Key findings
- The economy continues to defy forecasts of a recession, bolstering the confidence of economists who predict a “soft landing” from the high inflation we are experiencing.
- A soft landing would be at odds with the boom-and-bust history of the economy, which fell into recession every time inflation ran high.
- The main reason for hope to avoid a recession is the labor market, where workers remain in high demand due to the post-pandemic labor shortage.
Among the cautious optimists is Brad Case, chief economist at developer Middleburg Communities, who has been predicting a soft landing since late last year. Last week’s data showing growth in new home construction and building permits only made him more confident in that call. When Case incorporated this new data into a model predicting the odds of a recession in the coming year, the probability dropped from 70% to 53%.
“It’s going in the right direction,” Case said. “If I were just using the data, then I would say: Yes, I think we’re going into a recession. There’s a better chance of that than otherwise. When I use my judgment, I say I don’t think that’s what the data points to.”
Last spring and summer, many pundits looked to the horizon and saw a recession—a widespread and prolonged decline in many parts of the economy—coming within the next 12 months. And it’s still there, just over the horizon.
For example, Robert Fry, an independent economist, began 2023 with an estimate that a recession would occur in the first half of the year. He has now put that prediction on hold for the second half.
“The recession I predicted will come a little later than I expected,” he said in comments last week.
Inflation is a coming storm
Fears of a recession have been brewing since 2021, when prices of things suddenly in high demand and limited supply, such as cars and lumber, have soared, leading some economists to worry that inflation will become widespread. By the summer of 2022, inflation had reached its highest level in more than 40 years.
Rising prices sounded a recession alarm largely because the antidote to inflation in the past sent the economy into recession. To combat inflation, the Federal Reserve began raising its benchmark interest rate in March 2022, taking it from near zero to more than 5% in just over a year.
This approach has worked in the past at a high cost: almost every time the Federal Reserve has raised interest rates to high levels, a recession has followed.
In September, billionaire Barry Sternlicht complained in an interview with CNBC that the Federal Reserve was “attacking the economy with a sledgehammer,” noting that the housing market had stalled amid higher mortgage rates and forecasting a widespread recession and job losses.
Yet these massive job losses have yet to materialize, bucking the historical pattern.
Federal Reserve Chairman Jerome Powell said at a news conference on May 3 that he still expects the economy to avoid the worst.
“It shouldn’t have been possible for vacancies to go down as much as they did without unemployment going up,” he said. “It just seems to me that it’s possible that we could continue to have a cooling labor market without having the large increases in unemployment that have been seen in many previous episodes.”
In addition to unemployment being at a record low, incomes are also stable: After adjusting for inflation, household incomes, excluding money given to people by the government, rose 1.2 percent in April from a year earlier.
And consumer spending, while showing signs of slowing, is still rising, according to recent data. For example, retail sales in April rose 3.1 percent from April 2022, Census Bureau data showed last week.
“There’s a lot of strength in the labor markets, there’s a lot of strength in consumption, there’s a lot of strength in income growth,” Case said. “These are the three pillars of macroeconomics.
The risks still exist
There are still many threats to this continued prosperity.
Buyers struggling with high inflation and pressured by high borrowing costs are using up the savings they built up during the pandemic and may be forced to cut back on spending. This is ominous for the economy, as consumer spending is the main driver of economic growth, accounting for 68% of gross domestic product.
In addition, banks have become more defensive and made it more difficult to get credit, making life even more difficult for businesses and individuals trying to get the loans that keep the economy going.
The Fed’s record for raising interest rates without causing a recession is poor, according to a March 2022 report by economists at Piper Sandler, which found that of the last nine times the Fed has raised rates, a recession has followed eight times and only in 1994 did the Federal Reserve actually make something of a soft landing.
Bond trading data also added to recession fears. The yield curve, which compares the yield on long-term and short-term debt securities, shows that traders currently expect the Federal Reserve to be forced to cut interest rates in the near future in response to a recession.
But there is still hope for a soft landing
Although the yield curve and related indicators have a good track record of predicting recessions, they may not be as reliable as many economists assume, Case argued. This is because there has never been a soft landing from high inflation, so no one knows what the yield curve would look like before this scenario.
“We’ve never had a soft landing, so it’s just impossible to predict a direct soft landing,” Case said.
Although many economists still expect a recession, it is far from a sure thing. When the Wall Street Journal polled a group of 62 economists in April, they put the chances of a recession next year at an average of 61 percent, the same as they said in January.
Michael Pearce, chief US economist at Oxford Economics, wrote in a commentary this week that he predicts a recession in the near term, but sees an increasing chance that it will be delayed again or even reversed.
“Our baseline forecast is for a mild recession in the second half of the year, but we still think there is a possibility of a goldilocks scenario where the Fed returns inflation to its 2% target without pushing the economy into recession.”