Despite stock rally, recession in 2023 is still likely as Fed continues to raise rates

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A rebounding stock market isn’t an all-clear signal for the economy.

Stocks edged up Tuesday after a second report in less than a week showed inflation slowing, a development that could mean the Federal Reserve will dial back its most aggressive campaign of interest rate hikes since the early 1980s.

But that doesn’t mean the nation will dodge a recession next year, economists say.

Just 22% of economists believe the Fed will be able to dampen inflation without triggering a downturn, according to a survey of 50 economists Nov. 7-8 by Wolters Kluwer Blue Chip Economic Indicators. That’s down from 24% who believed the central bank could pull off a “soft landing” in October and 38% in September. The vast majority of the economists believe the slump will be mild.

The poll was taken before a report last Thursday revealed that consumer prices rose 7.7% in October from a year earlier, the smallest increase since January. A measure of underlying price increases that excludes volatile food and energy items also pulled back sharply, according to the Labor Department’s consumer price index.

The better-than-expected figures sent the S&P 500 index soaring 5.5%, its biggest jump since the spring of 2020. On Tuesday, the index rose as much as 1.85% after another report showed wholesale prices increased less than projected last month before giving back about half the gains by the market’s close. 

Will there be a recession in 2023?

But some economists say the good news on inflation doesn’t change their forecast for a modest recession in 2023 as the Fed continues to push interest rates higher, curtailing consumer and business borrowing and spending.

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“The fact that we got a good month isn’t enough to stop them from the path they’re on,” says Bob Schwartz, senior economist for Oxford Economics.

Fed officials have said they need to see several months of softening inflation before pausing their rate increases. Last year, price increases slowed briefly before surging anew, and a similar pattern occurred in the 1970s, Schwartz says.

“They’re still more concerned about prematurely stopping the rate increases than going too far,” Schwartz says, echoing Fed Chair Jerome Powell’s remarks early this month.

How much will the Fed raise interest rates?

At a UBS conference Sunday, Fed Governor Christopher Waller said the market overreacted to the encouraging inflation numbers, noting the Fed still has “a ways to go” before it can halt its rate hikes.

The Fed is just as worried about the slowing but still vibrant job market, says Jonathan Millar, senior U.S. economist at Barclays. That has been putting upward pressure on wages, forcing companies to pass their increased labor costs to consumers through higher prices.

“The labor market is too strong and will need to slow before they will pause,” Millar says. Employers added 261,000 jobs in October, well above the 190,000 economists expected, according to the Labor Department.

At the same time, last week’s inflation report convinced investors the Fed is poised to slow the pace of rate increases as soon as next month. After four three-quarters-point rate bumps – and a total of nearly 4 percentage points in hikes this year – markets that predict Fed actions reckon officials will raise its key short-term rate by a half point next month and pause after the rate reaches a range of 4.75% to 5% in March. Fed fund futures markets had expected the central bank to lift the rate to 5% to 5.25%.

“I think it will probably be appropriate soon to move to a slower pace of increases, but I think what’s really important to emphasize is … we have additional work to do,” Brainard said Monday, according to Reuters.

Will the Fed stop raising rates?

Though the Fed needs to see the labor market and inflation ease further before it pulls back, “there is compelling evidence that the inflation peak is behind us, and the retreat should continue,” Schwartz wrote in a note to clients.

More modest inflation and a less aggressive Fed won’t avoid a downturn, but “it reduces the risk of a severe recession,” Schwartz says.

Morgan Stanley believes the Fed will scale back even further, avoiding recession “by a whisker.” In a report Sunday, the research firm said it expects the central bank to stop hiking its key rate after it reaches a range of 4.5% to 4.75% early next year.

Besides cooling inflation – especially for goods such as used cars — the firm expects average job growth to slow significantly in coming months and bottom out at 50,000 by mid-2023. Moody’s Analytics predicts job growth will come to a standstill by then.

Read More: Despite stock rally, recession in 2023 is still likely as Fed continues to raise rates

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