Recession coming soon – recent fed decisions

Despite surprising strength in employment and housing demand, the U.S. economy continues to decelerate and Federal Reserve tightening is likely to lead to a “modest recession” in the final three months of 2023, economists at Fannie Mae predict.

In a forecast released Monday, economists with Fannie Mae’s Economic and Strategic Research (ESR) Group said that it’s hard to say precisely when a recession will hit. But forecasters at the mortgage giant say by the time Fed policymakers see data showing inflation has cooled enough to bring rates back down, a recession will probably be unavoidable.

“Our baseline expectation is that the Fed will keep monetary policy tighter until core inflation is clearly subdued, which is not likely to occur until there is clear evidence of labor market softening,” Fannie Mae forecasters said. “By the time that happens a recession will have likely been set in motion. We therefore see the Fed’s decision regarding how high and long to keep rates as a major risk over the next year, with the question of a downturn more a matter of ‘when’ than ‘if.'”

Since March 2022, the Fed has approved 10 rate increases, bringing the short-term federal funds rate to a target of between 5 percent and 5.25 percent. At their June 14 meeting, Fed policymakers held off on another rate hike but left the door open to future tightening.

Fed policymakers projected that the benchmark federal funds rate will need to come up by another half a percentage point before inflation is vanquished, and futures markets currently put the odds of a 25-basis point increase in July at 77 percent.

But the question is not only how high the Fed will raise rates, but how long it will keep them elevated. Fannie Mae forecasters say they suspect the Fed’s guidance that more rate hikes could be in store was also intended as a warning that policymakers will be in no hurry to cut rates.

“One of the historical lessons of the 1970-80s inflationary era was that inflation can easily come roaring back if monetary policy easing begins prematurely,” Fannie Mae economists said, noting that a rebound in oil prices or home prices could reignite inflation. “Until there is strong evidence of core inflation being contained, the worry of reaccelerating inflation via too-early policy easing will remain present.”

But if the economy does continue to slow, the Fed is expected to reverse course on rates this year or next — particularly if the U.S. enters a recession. The so-called “dot plot” from the Fed’s June 14 meeting shows most Fed policymakers don’t expect to cut rates this year, but they do see the federal funds rate coming down next year.

The CME FedWatch Tool, which tracks bets placed on futures markets, predicts a 66 percent chance that the Fed will have lowered rates by at least half a percentage point by this time next year.