Wall Street is predicting a 2023 recession. Here are the red flags you should know about
The U.S. economy added nearly half a million jobs in March. The Dow Jones industrial average is within 6% of its record high. And U.S. households accumulated roughly $2.5 trillion in excess savings throughout the pandemic.
Still, despite all the good news, predictions of an impending recession are widespread on Wall Street.
What’s driving the recent string of downtrodden economic forecasts?
Will history repeat itself?
For some, it’s a matter of historical comparison. Former Treasury Secretary Lawrence Summers emphasized in a recent Washington Post op-ed that current economic conditions are undeniably reminiscent of previous pre-recession periods in U.S. history.
“Over the past 75 years, every time inflation has exceeded 4% and unemployment has gone below 5%, the U.S. economy has gone into a recession within two years,” Summers wrote.
The yield curve inversion
Gary Pzegeo, the head of fixed income at CIBC’s U.S. Private Wealth division, told Fortune that he believes the majority of current recession predictions come from “market signals” like the recent, albeit brief, inversion of the yield curve.
A boom in commodity prices, the Federal Reserve’s decision to raise interest rates, and the war in Ukraine’s effects on global economic growth have acted to flatten the yield curve recently, Pzegeo argued. And when it inverted, it ignited fears of a recession.
After all, a 2s/10s yield curve inversion—where yields on short-term two-year government bonds outpace those on long-term 10-year government bonds—has predicted every recession since 1955, with only one false signal during that time. The average time frame for a recession after the yield curve inverts: between 6 and 24 months—hence, all the predictions of a recession by 2023.
Still, Pzegeo said that while the odds of an economic downturn have gone up in recent months as market signals have flashed red, CIBC still isn’t predicting a recession as its “base case.”
Inflation, war, and slowing growth
Other banks aren’t as optimistic. Deutsche Bank economists now see a recession coming by the end of 2023 as inflation becomes more broad-based.
“Two shocks in recent months, the war in Ukraine and the buildup of momentum in elevated U.S. and European inflation have caused us to revise down our forecast for global growth significantly,” a Deutsche Bank team led by economist David Folkerts-Landau wrote on Tuesday. “We are now projecting a recession in the U.S.…within the next two years.”
The economists noted that the war in Ukraine has disrupted global supply chains and dramatically increased commodity prices and energy costs in the U.S. and EU.
CIBC’s Pzegeo said that inflation can often lead to wealth destruction as well, especially when rising consumer prices outpace wage growth.
“It acts as a tax. So give it a little bit of time in the economy, and it’ll eat away at your wealth and set the stage for a recession,” he said.
Recent GDP forecasts from the Conference Board have also led to fears that a recession could be on the horizon. U.S. real GDP growth is now expected to slow to an annual rate of just 1.7% in the first quarter of 2022, compared with 7% annual growth seen in the fourth quarter of 2020.
Can the Fed save us?
For other economic forecasters, the Federal Reserve is the key to predictions of an impending recession.
Since the start of the pandemic, the central bank has supported the U.S. economy by maintaining near-zero interest rates that have helped spur lending. It has also flooded U.S. debt markets with cash in order to stimulate economic activity through an unconventional monetary policy called quantitative easing (QE).
Now, with pandemic restrictions fading and inflation moving to highs not seen in four decades, the Fed is faced with a difficult task: ensuring a so-called soft landing for the U.S. economy. The goal is to raise interest rates and end QE in order to cool economic growth and combat inflation—all without causing a recession.
“I really don’t know if they can engineer a soft landing,” Icahn said. “I think there’s going to be a rough landing.”
The billionaire now believes the U.S. economy will see a recession “or even worse” by the end of next year, and Deutsche Bank’s economists agree.
“We no longer see the Fed achieving a soft landing. Instead, we anticipate that a more aggressive tightening of monetary policy will push the economy into a recession,” the bank’s economists, led by Matthew Luzzetti, wrote in a recent note.
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