Odds of a U.S. recession have been hotly debated with the labor market and consumer spending showing resiliency even after some of the most aggressive interest rate hikes in history. But Deutsche Bank sees a 100% probability the U.S. will have one.
The short-term benchmark fed funds rate stands at the highest level since 2006, but inflation’s still twice the Fed’s goal. Fed Chairman Jerome Powell warned after the Fed’s policy committee meeting on Wednesday more rate hikes will likely be necessary to further cool inflation.
“Looking ahead, nearly all Committee participants view it as likely that some further rate increases will be appropriate this year to bring inflation down to 2% over time,” Powell said. The Fed’s median forecast for the fed funds rate this year at 5.6%, up from 5.1% in March and above the current fed funds target of 5% to 5.25%.
While more rate increases could bring inflation down to 2%, at what price? Recession, says David Folkerts-Landau, Deutsche Bank chief economist.
“The U.S. is heading for its first genuine policy-led boom-bust cycle in at least four decades,” he writes. “The inflation we see was induced largely by expansive fiscal and monetary policy, and the aggressive rate hikes needed to tame that have now materialized. Avoiding a hard landing would be historically unprecedented.”
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What’s Deutsche Bank’s prediction?
- Interest rates: at least one more 25-basis-point increase to the fed funds rate in July. “While some progress has been made on bringing the labor market into better balance and reducing inflation, both remain far from the Fed’s objectives,” it said.
- Consumer spending: slowing, with excess savings mostly spent by October.
- Unemployment rate: creeping up to just above 4% by year-end and 4.5% in the first three months of 2024. May’s jobless rate was 3.7%.
- Economic growth: a “moderate recession” beginning in the final three months of the year and continuing through the first three months of 2024. Next year, the economy will contract by 0.4%, compared to 1.4% growth this year.
- Inflation: Consumer Price Index (CPI) around 2.75% and the core CPI, excluding the volatile food and energy sectors, near 3.5% at year end. May’s CPI was 4%.
There are other risks, too
Geopolitics could affect the investment bank’s outlook, too. The Russia-Ukraine conflict could intensify as well as U.S.-China strategic competition.
“Another risk is a strong El Niño event leading to fresh inflationary pressures from higher food prices,” Folkerts-Landau’s team said.
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Are there any bright spots?
Yes, artificial intelligence (AI).
“Given a poor cyclical outlook, low productivity, and declining demographics, we are in desperate need of a new source of growth,” and AI could be it, Folkerts-Landau said. However, he said AI will take time to reap benefits – likely, not until later this decade.
In the near term, the expected drop in inflation and recession will prompt the Fed to start cutting rates in March 2024, he says. Just as the Fed aggressively raised the Fed funds rate, Deutsche Bank expects cuts to come just as fast “in 50-basis-point to 75-basis-point increments until reaching 2.625%.”
Medora Lee is a money, markets, and personal finance reporter at USA TODAY. You can reach her at mjlee@usatoday.com and subscribe to our free Daily Money newsletter for personal finance tips and business news every Monday through Friday morning.
