Recession Risks Are ‘Rising’ As Federal Reserve Scrambles To Fight Inflation, Experts Say

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Topline

With the Federal Reserve set to aggressively raise interest rates and tighten monetary policy as it scrambles to confront decades-high inflation, Wall Street experts are now warning that doing so too quickly could spark a sharp economic downturn, market turmoil and even the next recession.

Federal Reserve Chairman Jerome Powell speaks during his re-nominations hearing in January.

Brendan Smialowski/Pool via ASSOCIATED PRESS

Key Facts

Investors have become increasingly nervous about the Federal Reserve’s aggressive interest-rate-hiking cycle and reversal of pandemic-era stimulus programs—a prospect which now has many Wall Street experts sounding the alarm about the potential impact to markets and the economy.

Bank of America’s chief investment strategist, Michael Hartnett, warned in a note on Friday that “recession risks [are] rising,” as he sees a scenario in the next six months where “rates shock morphs into recession shock.”

Other prominent economists—from across the political spectrum—have also been warning of a recession within the next couple of years, with several putting the odds of a downturn at over 50%.

The central bank now has to play catchup to fight inflation, which has proven to be worse than expected, putting the odds of a recession by the end of 2023 at over 50%, according to former Fed Governor Lawrence Lindsey, who served in the George W. Bush administration.

Ex-Treasury Secretary Lawrence Summers, meanwhile, put the chances of a near-term recession—within the next 30 months—at above 50% because “the Fed has allowed itself to get far further behind the curve” in battling inflation.

Minneapolis Fed President Neel Kashkari warned earlier this week that the central bank shouldn’t “overdo it” on rate hikes by raising them too fast or too far, as it would raise the risk of “slamming the brakes on the economy” and “putting the economy into recession.”

What To Watch For:

One of Wall Street’s most popular recession indicators has gained attention in recent weeks as the Federal Reserve gears up to aggressively raise rates: If the yield curve inverts in 2022 that may well signal that a recession is coming. While the yield curve still has a largely upward slope, it has begun flattening somewhat in recent months as government bond yields surge. A study from the Federal Reserve Bank of San Francisco in 2018 showed that a yield curve inversion preceded every recession except one since 1955. The last time this happened was in 2019, before the onset of the coronavirus pandemic plunged the U.S. economy into a recession in early 2020. “I am intently focused on the yield curve,” Matthew Nest, global head of active fixed income at State Street Global Advisors, recently told Reuters. “The only way the Fed can bring down inflation is to slow demand… and in doing so it risks causing a recession or a sharp slowdown in growth.”

Tangent:

While most experts attribute rising recession risks to the Fed’s upcoming interest rate hikes and tightening monetary policy, some are also warning about the potential impact of a Russian invasion of Ukraine. The stock market has been especially weighed down by this political uncertainty in recent weeks amid rising tensions between Russia and the West as military buildup continues on Ukraine’s border. If Russia does invade, that would pose another significant risk for markets and “materially increases the odds of a polar vortex for the economy and earnings,” says Morgan Stanley chief U.S. equity strategist Michael Wilson in a recent note. The subsequent spike in energy prices under that scenario “would destroy demand, in our view, and perhaps tip several economies into an outright recession.”

Contra:

“Despite recent volatility, it’s important to remember that we are still in an environment of robust economic and earnings growth, and in our base case we expect upside for equity markets over the balance of the year,” according to a note from Mark Haefele, chief investment officer at UBS Global Wealth Management, earlier this week. “Our base case is that inflation will fall and geopolitical tensions will ease over the coming months, allowing markets to move higher.”