The United States is at growing risk of plunging into a recession, a prospect that is spooking some economists as inflation further ensnarls the country.
Inflation is running at levels not seen since the 1980s, and the Federal Reserve appears poised to act even more aggressively to rein it in. To drive down the higher prices, the Fed must hike interest rates, a move that slows spending. The concern is that the Fed is so far behind on doing so that it might knock the economy into a recession as it does battle with inflation.
Desmond Lachman, a senior fellow at the American Enterprise Institute, pointed out that the yield on certain shorter-run Treasury notes has increased higher than certain longer-run notes, something that is called an “inversion.”
The sign means that investors believe inflation won’t be a problem over the long run because the economy is going to enter a recession, Lachman said, noting that the indicator has been reliable at predicting recessions since the post-war period. He said that every time yield curves have inverted, there has been a recession within six to 24 months.
“The bond market is a lot more accurate than the stock market at these things,” Lachman told the Washington Examiner.
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The flattening yield curves come after the Fed announced it would raise its interest rate target by a quarter of a percentage point, the first rate hike since 2018. Fed Chairman Jerome Powell has also signaled that the central bank might be more aggressive in hiking rates at its forthcoming meetings in response to the country’s breakneck inflation.
In the most recent iteration of the Fed’s minutes, which were released last week, it was revealed that the central bank officials found the labor market too hot and are considering a more aggressive hike for the May meeting. The Fed also intends to reduce the size of its balance sheet by $95 billion a month, a much more hawkish position than the previous months.
The shift in recessionary fears among economists is significant. The Wall Street Journal found in its regular survey of economists that the share predicting a recession is on the rise.
A year ago, just about 1 in 10 of the economists surveyed predicted the onset of a recession in the next 12 months. The number leaped to 18% at the start of this year and is now registering at 28%. Those surveyed also slashed their average growth forecasts because of the higher prices and coming barrage of rate increases.
Lachman and other economists have expressed doubt about the Fed’s ability to conduct a “soft landing” — that is, pushing down inflation without depressing economic growth so much that the country enters a recession.
“The Fed has never managed to get a soft landing when inflation has gone above 4%,” Lachman said, noting how high inflation is now. “There’s no way they’re going to get that down without a recession, so I think that’s why people are shifting — because they can see inflation is a bigger problem than they thought before.”
Lachman said predicting the timing and odds of a recession is difficult for economists to do but pegged the odds at greater than 50% and said the economy could enter one before the end of this year.
He also said there are bubbles in the equity and housing markets subject to being burst by interest rate hikes, which could bring on a recession.
The war in Ukraine has further complicated matters because it has raised energy prices, driving up inflation even further and making the Fed’s job of bringing down prices and achieving a soft landing even more difficult.
Amy Crews Cutts, of AC Cutts & Associates LLC, noted hotter inflation because of the war’s effect on commodity prices, which the Fed has little control over. She predicts a 70% chance of a recession in the next year.
“To be seen not fighting it is politically unwinnable. But the only policy response the Fed has is to tighten,” Cutts told the Wall Street Journal. “Fed actions to curb inflation will lead to a recession sooner rather than later.”
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The high inflation has created headaches for the Biden administration and Democrats, who are gearing up for a tough midterm election fight later this year.
A recent poll found that the share of people saying inflation is the country’s leading problem has more than doubled in the past three months. Additionally, 67% of small-business owners say President Joe Biden is not doing enough to beat back the country’s historically high inflation, according to another poll released last week.
