In April 2022, with the Ukraine war in its early stages and inflation raging near a four-decade high, Deutsche Bank became the first major investment bank to predict a U.S. recession. The 153-year-old German institution’s chief economist, David Folkerts-Landau, argued the rise of inflation would ultimately force the Federal Reserve to rapidly hike interest rates—“to err on the side of doing too much”—sparking a “mild” recession by late 2023 or early 2024.
Folkerts-Landau waffled on the mild part of that forecast in the following months. He feared the U.S. may experience a more “major” recession when the Fed was struggling to control inflation, but eventually switched back to his original “mild” outlook.
While many Wall Street economists have become increasingly optimistic over the past year, arguing that the economy will experience a “soft landing” in which interest rate hikes tame inflation without sparking a job-killing recession, Folkerts-Landau and his Deutsche Bank colleagues remain concerned.
“Over the last two to three years we’ve had a fairly consistent macro narrative, viewing this as a classic policy-led boom-bust cycle that would culminate in a U.S. recession towards the end of 2023,” he wrote in a Monday note with Jim Reid, Deutsche Bank’s head of global economics and thematic research. “We think our narrative still holds,” they added, arguing the mild recession is already “materializing.”
It’s a classic ‘policy-led boom-bust cycle’
Folkerts-Landau and Reid believe that the U.S. economy has been weighed down by years of inflation and rising interest rates, and it will eventually crack despite more recent positive economic data, including the stronger-than-expected third quarter GDP numbers and multiple promising inflation reports.
“Monetary policy famously operates with lags which are highly uncertain in their timing and impact,” they wrote, arguing a “mild recession” will take place in early 2024 at the latest.
Folkerts-Landau and Reid pointed out that based on past interest rate hiking cycles, if the U.S. recession had fallen into a recession this year it “would have been early.”
“Looking back at 13 Fed hiking cycles since the 1950s, only one has rolled over into a recession within 18 months of the hikes starting. But a further six have rolled over between 19 and 28 months, which is the period we entered last month,” they noted.
The pair argue the next two to three quarters will be a period of “peak” recession risk based on historical evidence. “We can already see clear signs of data softening,” they wrote, pointing to the fact that the unemployment rate is now at its highest level since January 2022 (although it is still just 3.9%) and credit card delinquencies just hit 12-year highs.
“At the outer edges of the economy there is obvious stress that is likely to spread in 2024 with rates at these levels,” they added.
A mid-2024 turnaround—and an AI lift
The good news is Deutsche Bank expects a midyear turnaround for the economy.
Folkerts-Landau and Reid believe Fed officials will begin cutting interest rates next year after the U.S. economy falls into recession and inflation fades back to near their 2% target. That should enable the economy to slowly regain its footing. And Deutsche Bank’s equity research team believes the rate cuts will also help stocks soar 11% to a new record high.
Over the medium-term, Folkerts-Landau and Reid are more bullish, too. Despite the threat of war or sanctions amid rising geopolitical tensions, artificial intelligence is likely to rapidly increase productivity and help the economy thrive, according to the Wall Street veterans.
“While our economic forecasts for the [developed markets] world suggest a sober outlook at best, the next 12 months could see more evidence that AI will revolutionize productivity growth later this decade,” they wrote Monday. “So the medium-term future looks more promising than it has done for some time.”
The pair said it’s difficult to determine the scale of the productivity growth that AI could bring, but they do expect a “material bump.” The evidence is in their corner. Data from consulting firm McKinsey shows generative AI technologies, from ChatGPT to DALL-E, could enable annual global productivity gains of between $2.6 trillion and $4.4 trillion. That’s potentially more than the U.K.’s 2022 GDP of just over $3 trillion.
It makes sense that Deutsche Bank’s economists are so bullish on AI, and not just because of the data. If Folkerts-Landau and Reid head down to the software department at Deutsche Bank, they’ll see software engineers are already using AI. And if they listen to some of the investment bankers, they’ve probably heard that many are using AI in their credit risk models.
Overall, Folkerts-Landau and Reid said all of this makes AI an “enticing prospect” for the global economy. “Try to remember that as the world flirts with recession in 2024,” they concluded.
