US Recession Likely, Says Deutsche Bank Chief Economist

While the US Federal Reserve and some economists are predicting that the US economy is headed toward a soft landing after the rampant inflation and high interest rates during the past two years, there is a dissenting voice about the trajectory of the world’s largest economy.

Chief Economist David Folkerts-Landau at Deutsche Bank said in research published on June 7 that a US recession will be much more significant than the consensus view. Folkerts-Landau said that a recession is being driven by government policy. This contrasts with the few of the Federal Reserve and the chief economist of the National Retail Federation.

“The US is on track for its first genuine policy-led boom-bust cycle in four decades, induced by a significant increase in the money supply over 2020- 21, unleashing high inflation and an aggressive policy response,” Folkerts-Landau wrote. “Our prediction is for a -1.25% peak to trough US GDP decline, milder than the average post-WWII recession, but aggressive versus the consensus.”

The sudden shift from 10-15 years of zero or negative rates and near continuous quantitative easing has left US businesses, consumers and investors struggling to adjust to “the recent rate shock,”

Folkerts-Landau said. The increase in US rate led to “accidents” such as the collapse of US regional banks, including Silicon Valley Bank and First Republic Bank.

Fed Rate Hikes

The Fed has raised interest rates during the last 14 months at the fastest pace in 40 years as it tries to get inflation back to its target level of 2%. It hiked its benchmark federal funds rate at 10 straight meetings by a total of 5 percentage points since March 2022.

The Fed decided to pause its rate increases during its Federal Open Market Committee meeting June 13-14, the first time since January 2022 that it has held its key rate steady.

“Holding the target range steady at this meeting allows the Committee to assess additional information and its implications for monetary policy,” the Fed said in its FOMC statement on June 14. “The Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.”

Fed Chief Jerone Powell will face questions from lawmakers on June 21 and 22, his first testimony on Capitol Hill since early March, before banking-sector turmoil prompted sharp criticism of the Fed and forced officials to rethink their policy strategy. Since then, the most acute financial strains have eased, but questions remain about the extent to which tighter credit will weigh on the economy, and what that means for the Fed.

Too High

Deutsche’s Folkerts-Landau doesn’t think the rate hiking cycle is over.

The Fed, as well as the European Central Bank and theBank of England, “likely to hike once, twice and three times more respectively and with the risks on the hawkish side,” he said. “Core inflation is proving too high for comfort and recessionary conditions may be the only way of returning it to target.”

Inflation, measured by the key Consumer Price Index, has shown some signs of cooling since the Fed embarked on its aggressive plan to tame price pressures from 40-year highs reached last year. May's reading showed inflation rose by 4.0%. This time last year, the Consumer Price Index was more than double at 8.6%.

National Retail Federation (NRF) chief economist Jack Kleinhenz said in the June edition of NRF’s Monthly Economic Review that the Fed’s rate increases have been slowing the economy but not so much as to tip it into recession.

Modest Pace

The FED said on June 14 that recent indicators suggest that economic activity has continued to expand at a modest pace as job gains have been robust in recent months, and the unemployment rate low. US gross domestic product, a measure of all goods and services produced for the period, rose at a 1.1% annualized pace in the first quarter, the Commerce Department reported in April.

“Consumer spending has been bolstered by a strong job market and rising wages, which have helped counter rising prices and higher borrowing costs,” Kleinhenz said. “While it’s difficult to reconcile these views, what we’ve learned over the last several years is don't count the American consumer out, at least not yet.”

But for Deutsche, it is a matter of when the economy will tip into recession, not if.

“We always thought it would take until the latter part of 2023 for this to materialize and although there is a risk it's delayed until H1 2024, we continue to believe it starts in Q4 2023.”