US recession in 2023 now seems more likely than not

Summary

• We are changing our base case forecast for next year from an economic soft landing to a mild recession starting in mid-2023.
• Recent data suggest that inflation is becoming increasingly entrenched in the economy. High inflation is eroding real income, which likely will weigh on consumer spending growth in coming quarters.
• Additionally, the Federal Reserve is becoming increasingly more hawkish. The FOMC has already raised its target range for the federal funds rate by 150 bps since March, and we look for the Committee to hike rates by an additional 275 bps by early next year. Higher interest rates will eventually depress interest-rate sensitive spending.
• Other financial conditions have tightened significantly recently. Credit spreads have widened, most major stock market indices have slipped into bear market territory, and the dollar has strengthened considerably. Tighter financial conditions will also impart slowing effects on the economy.
• Many underlying fundamentals generally remain sound. Household and business balance sheets are generally in good shape, and the banking system is well capitalized. Consequently, we do not expect the downturn we are forecasting to be especially deep or prolonged.
• In our view, the recession will be more or less equivalent in magnitude and duration to the downturn of 1990-1991. That recession lasted for two quarters with a peak-to-trough decline in real GDP of 1.4%.
• Recession next year is not necessarily assured, and the Fed may still be able to pull off an economic soft landing. But prospects of a soft landing are looking increasingly less credible, and we now judge that recession next year is more likely than not.

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