Economists are cutting back their recession expectations

Forecasters still expect GDP to eventually contract, but later, and by less, than previously.

Economists are dialling back recession risks in the US.

Easing inflation, a still-strong labour market and economic resilience led business and academic economists polled by The Wall Street Journal to lower the probability of a recession in the next 12 months to 54 per cent from 61 per cent in the previous two surveys.

While that probability is still high by historical comparison, it represents the largest month-over-month drop since August 2020, as the economy was recovering from a short but sharp recession induced by the Covid-19 pandemic.

It reflects the fact that the US economy has kept growing even as the Federal Reserve has raised interest rates and inflation declined.

In the latest survey, economists expected GDP to have grown at a 1.5 per cent annual rate in the second quarter, a sharp uptick from 0.2 per cent in the previous survey. They still expect GDP to eventually contract, but later, and by less, than previously. They expect the economy to grow 0.6 per cent in the third quarter, in contrast to the 0.3 per cent contraction expected in the prior survey, followed by a 0.1 per cent contraction in the fourth. Forecasters said GDP would increase 1 per cent in 2023, measured from the fourth quarter of a year earlier, double the previous forecast of 0.5 per cent.

Nearly 60 per cent said their main reason for optimism about the economic outlook is their expectation that inflation will continue to slow. The Labor Department’s consumer-price index climbed 3 per cent in June from a year earlier, sharply lower than the peak of 9.1 per cent in June 2022 and the slowest in more than two years. The Fed’s preferred inflation measure – the annual change in the personal consumption expenditures price index excluding food and energy – has fallen from 5.4 per cent in March 2022 to 4.6 per cent in May. Economists expect it to reach 3.7 per cent by the fourth quarter, though that is still well above the Fed’s 2 per cent target.

Pathway to a soft landing

Many economists first began in the middle of last year to project a recession when persistently high inflation prompted the Fed to raise rates at the most aggressive pace in nearly three decades. Historically, lowering the inflation rate materially has always involved higher unemployment and a downturn, and few thought this time would be different.

Now, a pathway to achieve a “soft landing”. or getting inflation down without a recession, is “back on the table”, said Sean Snaith, the director of the University of Central Florida’s Institute for Economic Forecasting.

“At the beginning of this year it seemed more of a pipe dream,” said Snaith. Now, “it seems a recession keeps slipping, slipping, slipping into the future.” He has lowered the probability of recession to 45 per cent from 90 per cent in April.

On average, economists still expect the labour market will lose 10,551 jobs a month in the first quarter of 2024, broadly unchanged from their previous forecast. But unlike in the April survey, economists no longer expect job cuts in the third and fourth quarter. They expect employers will add jobs in the second and third quarters of next year, suggesting any downturn will be mild.

“Inflation has slowed remarkably already, and we believe will continue to do so because spending growth is slowing substantially and the growth in labour force is helping service providers,” said Luke Tilley, chief economist at Wilmington Trust.

Still, stronger-than-expected growth this year will also likely result in the Fed keeping interest rates higher for longer.

Economists expected the midpoint of the range for the fed funds rate will peak at 5.4 per cent in December. The latest prediction implies at least one more 25 basis point increase by the Fed.

More rate increases, later rate cuts

The Fed last month held its benchmark funds rate steady in a range between 5 and 5.25 per cent, its first pause after 10 consecutive increases since March 2022. Market participants overwhelmingly expect the central bank will raise rates by a quarter-percentage point at its July 25-26 meeting, according to the futures market.

Economists are also pushing back estimates for when the Fed will eventually start cutting rates. In the latest survey, only 10.6 per cent expected a rate cut in the second half of this year, down from 36.8 per cent in the last survey. The majority, nearly 79 per cent, expected the Fed will cut rates in the first half of 2024 as the unemployment rate rises. Some 42.4 per cent expected that first cut will come in the second quarter.

Economists are relatively sanguine about the impact of the end of the government’s pandemic-era pause on student debt payments, which allowed millions of Americans to avoid a big monthly bill for more than three years.

The resumption of student loan payments is expected to have a relatively minor impact this autumn, shaving 0.2 percentage points, annualised, from consumer spending growth, measured from the third quarter to the fourth quarter of this year.

“We will likely see some slowing in spending growth toward the end of this year as a result of the resumed payments denting certain households’ ability to consume, but we do not think the end to the payment pause will be widespread enough to have a significant effect on overall household spending,” said Wells Fargo chief economist Jay Bryson.

The survey of 69 economists was conducted July 7-12. Not every economist answered every question.

The Wall Street Journal