It seems that America is avoiding recession. what could go wrong?

It seems that America is avoiding recession.  what could go wrong?

With inflation falling, unemployment low and the Federal Reserve signaling it may soon start cutting interest rates, forecasters are becoming increasingly optimistic that the US economy can avoid a recession.

Wells Fargo last week became the latest big bank to predict that the economy will grow at a slower rate, slowing rather than stopping. The bank’s economists were predicting a recession as early as mid-2022.

Yet if forecasters were wrong last year when predicting a recession, they may be wrong again, this time in the opposite direction. The risks to 2023 that economists highlighted have not gone away, and recent economic data, though still mostly positive, is suggesting some cracks beneath the surface.

Indeed, on the same day that Wells Fargo reversed its call for a recession, its economists also published a report pointing to signs of weakness in the labor market. He said hiring has slowed and recent job gains have included only a few industries. Layoffs remain low, but workers who lose their jobs have difficulty finding new ones.

“We’re not out of the woods yet,” said report author Sarah House. “We still think recession risks are still elevated.”

Ms House and other economists have stressed that there are good reasons for their recent optimism. The economy has weathered the sharp rise in interest rates better than most forecasters expected. And the surprisingly sharp slowdown in inflation has given policymakers more leeway — for example, if unemployment starts rising, the Fed could cut rates to try to prolong the recovery.

If a recession occurs, economists say there are three main ways it could go:

The main reason economists predicted a recession last year was that they expected the Fed to cause one.

Fed officials spent the past two years trying to curb inflation by raising interest rates at the fastest pace in decades. The goal was to reduce demand just enough to reduce inflation, but not so much that companies would start mass layoffs. Most forecasters – including many inside the central bank – thought that such careful calibration would prove too difficult and that once consumers and businesses began to hold back, a recession was almost inevitable.

It is still possible that his analysis was correct and it was just the timing that was wrong. It takes time for higher interest rates to impact the economy and there are reasons why this time the process may be slower than usual.

For example, many companies refinanced their debt during a period of extremely low interest rates in 2020 and 2021; Only when they need to refinance again will they feel the sting of higher borrowing costs. Many households were able to forego the higher rates because they had already saved or paid down debt during the pandemic.

However, those buffers are running out. By most estimates, excess savings are dwindling or have already been exhausted, and credit card borrowing is setting records. High mortgage rates have slowed the housing market. Student loan payments, which were paused for years during the pandemic, have resumed. State and local governments are cutting their budgets as federal aid ends and tax revenues decline.

“When you look at all the supports that consumers have received, a lot of those supports are being reduced,” said Dana M. Peterson, chief economist at the Conference Board.

The manufacturing and housing sectors have already experienced a recession, Ms. Peterson said, with output falling, and business investment more broadly lagging. Consumers are the last pillar holding up the recovery. He added, “If the job market weakens even a little bit, that could wake people up and make them think, ‘Okay, I can’t be fired, but I can be fired. And at least I won’t get such a big job.” Bonus,” and reduce your spending accordingly.

The biggest reason economists are more optimistic about the possibility of a soft landing is the rapid cooling of inflation. By some short-term measures, inflation is now barely above the Fed’s long-term target of 2 percent; The prices of some physical goods, such as furniture and used cars, are actually falling.

If inflation is under control, this gives policymakers more room to maneuver, allowing them, for example, to cut interest rates if unemployment begins to rise. Already, Fed officials have signaled they expect to start cutting rates sometime this year to keep the recovery on track.

But if inflation rises again, policymakers could find themselves in a difficult position, and unable to cut rates if the economy loses momentum. Or worse, they may be forced to consider raising rates again.

“Despite strong demand, our inflation is still coming down,” said Raghuram Rajan, an economist at the University of Chicago Booth School of Business who has held top positions at the International Monetary Fund and the Bank of India. “The question now is, will we be so lucky in the future?”

Inflation fell in 2023 partly because the supply side of the economy improved significantly: supply chains largely returned to normal after disruptions caused by the pandemic. Immigration rebounding and Americans returning to the job market also brought an influx of workers into the economy. This meant that companies could obtain the materials and labor needed to meet demand without raising prices.

However, some expect a similar supply resurgence in 2024. This means that a slowdown in demand may be required for inflation to continue to decline. This may be especially true in the services sector, where prices are more strongly tied to wages – and where wage growth remains relatively strong due to demand for workers.

Financial markets could also make the Fed’s job more difficult. Both the stock and bond markets rallied late last year, which could effectively cancel out some of the Fed’s efforts by making investors feel richer and allowing corporations to borrow more cheaply. This could help the economy in the short term, but would force the Fed to act more aggressively, increasing the risk that it would cause a recession in the future.

Federal Reserve Bank of Dallas President Laurie K. “If we do not maintain sufficiently tight fiscal conditions, there is a risk that inflation will rise again and the progress we have made will be reversed,” Logan warned this month. in a speech At an annual conference for economists in San Antonio. As a result, he said, the Fed should keep open the possibility of another increase in interest rates.

The economy got some lucky breaks last year. China’s weak recovery helped keep commodity prices in check, which contributed to the slowdown in US inflation. Congress averted a government shutdown and resolved the debt-ceiling impasse with relatively little drama. The outbreak of war in the Middle East had only a minor impact on global oil prices.

There is no guarantee that the luck will continue in 2024. The widespread war in the Middle East is disrupting shipping lanes in the Red Sea. Congress faces another government funding deadline in March after passing a stopgap spending bill on Thursday. And new threats could emerge: more deadly coronavirus strains, conflict in the Taiwan Strait, crises in some previously obscure corner of the financial system.

Any of these possibilities could upset the balance the Fed is trying to achieve by causing either an increase in inflation or a decline in demand – or both.

“This is the thing that keeps you up at night if you’re a central banker,” said Karen Dynan, a Harvard economist and former Treasury Department official.

Although such risks are always present, the Fed has very little margin for error. The economy has slowed considerably, leaving little buffer against further impacts on growth. But with inflation still elevated – and memories of high inflation still fresh – the Fed may have difficulty ignoring even a temporary rise in prices.

“There is room for error on both sides, which could lead to lost jobs,” Ms Dynan said. “The risks, certainly, are more balanced than they were a year ago, but I don’t think it’s providing that much comfort to decision makers.”

produced by audio Patricia Sulbaran,

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