“Imagine no recession, it’s easy if you try.”
That was the title of Bank of America Research’s latest U.S. Economic Viewpoint research note, which details chief U.S. economist Michael Gapen’s outlook for the economy. It was quite the departure from the consistent recession predictions Gapen has put forward since last summer.
Just over a year ago, the former Barclays exec took the reins of BofA’s economic research team and quickly added his name to a growing chorus of Wall Street leaders forecasting a recession. Rising interest rates and stubborn inflation were weighing on consumers, and would ultimately spark at least a “mild recession” by the end of 2022, he warned at the time.
Since then, Gapen has been forced to revise the timing of that forecast on multiple occasions. Last September, he moved the recession goalpost to the second half of 2023, noting that there was “underlying momentum” in the economy despite the Federal Reserve’s aggressive interest rate hikes.
Then in June, Gapen said we could see something more like a “growth recession,” owing to “evidence of resilience” in the labor market, and argued the “mild recession” wouldn’t come until 2024. Finally, last month, although he doubled down on his “mild recession” call for next year, Gapen was again forced to admit that recent economic data had “surprised to the upside” and clients were feeling “generally optimistic.”
Now, nearly all of Gapen’s pessimism has fallen by the wayside.
“Recent incoming data has made us reassess our prior view that a mild recession in 2024 is the most likely outcome for the U.S. economy,” he wrote to clients Wednesday. “We revise our outlook for the U.S. economy in favor of a soft landing, where growth falls below trend in 2024, but remains positive throughout our forecast horizon.”
So why did Gapen change his mind? It’s instructive to look under the hood of his remarks, but also to compare his outlook with Goldman Sachs, which has been leaning toward a soft landing for many months now.
A new outlook
While many economists were expecting economic growth to fade this year as rising interest rates increased the cost of borrowing for business and consumers, it just hasn’t turned out that way, as Gapen acknowledges. U.S. GDP growth was revised up to 2% for the first quarter, and it came in at 2.4% in the second quarter, well ahead of economists’ consensus forecast for 1.5%.
On top of that, Gapen and many of his peers had feared that rising interest rates would cause the unemployment rate to surge. Instead, the record job openings that were a feature of the past few years have dropped, but the unemployment rate has remained near an all-time low. The payroll firm ADP even reported this week that employers added another 324,000 jobs last month, topping economists’ expectations for 189,000.
Goldman Sachs’ chief economist Jan Hatzius has been predicting this type of “reduction in job openings without a sharp rise in unemployment” since last September, arguing it will help slow inflation and enable a soft landing for the U.S. economy. Hatzius has held odds of a U.S. recession between 25% and 35% over the past year, near a Wall Street low. Now, Gapen is starting to sound a lot like his more optimistic peer.
Just take his view on inflation. After peaking at 9.1% last summer, year-over-year inflation dropped to just 3% in June. Many economists feared a wage-price spiral would lead inflation to get “sticky” at 4% to 5%, but Gapen said that “wage and price pressures are moving in the right direction” now, making that less likely.
“What is interesting to us and, in part, is what is behind our revised outlook for the U.S. economy, is that resiliency in activity and labor markets has not prevented softening in inflation and wages,” he noted.
The economist pointed to the employment cost index (ECI), which measures compensation costs across the economy, as evidence that inflationary pressures are easing despite continued economic growth. In June, the ECI showed that compensation costs increased 4.5% year over year, compared with 5.1% during the same period a year ago.
“The ECI data confirm the moderation in wage growth in other wage measures including average hourly earnings, the Atlanta Fed wage tracker, and Indeed’s wage tracker—a measure of posted-job wage inflation,” Gapen explained.
Even sectors that are the most sensitive to changes in interest rates, like manufacturing and housing, “have shown signs of stabilization” in recent months, according to the economist.
‘The outcome least supported in the postwar period’
After predicting that U.S. GDP growth would fall to 0% next year for months now, this positive economic data led Gapen to revise his forecast to 2% GDP growth for 2023, 0.7% for 2024, and 1.8% for 2025 on Wednesday.
As far as the unemployment rate, the bank now expects it to peak at 4.3% in the first quarter of 2025, compared with their previous estimate for a peak of 4.7% in the fourth quarter of 2024.
“The labor market should continue to cool and employment growth should moderate, but not as much as we forecasted previously,” Gapen wrote.
The economist said he also expects “inflation to decelerate and remain on a path to 2.0%,” but owing to the ongoing and unanticipated strength in the labor market, it will fall “more gradually” than previously anticipated. The Fed’s favorite inflation gauge, the personal consumption expenditures (PCE) price index, won’t drop to its 2% target until the second half of 2025, he argued. Still, that would likely be enough to allow the Fed to slowly end its interest rate hiking campaign next year.
“If our outlook proves true, this would be good news for the Fed,” Gapen said, explaining that he now expects just one more rate hike this year followed by rate cuts starting next June.
Gapen isn’t alone in his shifting view of the U.S. economy, either. After warning that a “mild recession” was coming within a year just months ago, Federal Reserve Chair Jerome Powell said his staff are no longer forecasting a recession at July’s Federal Open Market Committee meeting. The staff’s forecast is separate from that of Powell and voting members of the Federal Reserve Board, but it illustrates the growing optimism among economists—as do the polls. Last December, economists polled by Bloomberg said there was a 70% chance of a U.S. recession, but in July those odds improved to 58%.
Despite the newfound optimism of Gapen and his peers, the chief economist concluded his Wednesday research note with a warning.
“While we are removing our outlook for a mild recession and replacing it with a soft landing, we acknowledge that we are moving to the outcome least supported in the postwar period,” he wrote, noting that there have been 11 recessions, but only three “soft landings” since World War II. “A lot still has to go right.”
