For more than a year, economists have been waiting for a recession to arrive—but it keeps standing them up, and it might be called off completely.
The resilience of the job market has bolstered the hopes of economists who believe that the Fed can cool inflation while avoiding mass layoffs—a scenario that Fed officials call a “soft landing.” The Fed’s favorite measure of inflation, Personal Consumption Expenditures, has fallen from its peak of a 7% annual increase to 4.4% despite an uptick in April, more than halfway towards the Fed’s inflation target of 2%. Meanwhile, the unemployment rate dipped to 3.4% in April, matching its lowest since 1969.
Past downturns, such as the Great Recession, have included business failures, mass layoffs, the destruction of wealth, and economic misery affecting millions. That’s all been avoided, at least so far, as the economy has resisted all the powerful forces dragging it down.
Among the cautious optimists is Brad Case, chief economist at developer Middleburg Communities, who has been predicting a soft landing since late last year. Data last week showing an uptick in new home construction and building permits has only made him more confident in that call. When Case plugged that new data into a model forecasting the chances of a recession in the next year, the probability fell from 70% to 53%.
“It's going in the right direction,” Case said. “If I used only the data, then I would say, Yeah, I think we're going into recession. There's a better chance of that than otherwise. When I use my judgment, I say I don't think that's what the data is pointing to.”
Last spring and summer, many experts looked to the horizon and saw a recession—a widespread and prolonged downturn across many parts of the economy—coming within the next 12 months. And it’s still there, just over the horizon.
For example, Robert Fry, an independent economist, began 2023 with an estimate that a recession would arrive in the first half of the year. He’s now pushed that forecast back to the second half.
“The recession I’ve been forecasting will arrive a little later than I expected,” he said in a commentary last week.
Fears of a recession have been brewing since 2021, when prices for things suddenly in high demand and limited supply, such as cars and lumber, surged, prompting some economists to worry that inflation would become widespread. By the summer of 2022, inflation had hit its highest in more than 40 years.
The surging prices sounded recession alarm bells largely because the cure for inflation has historically sent the economy diving into a recession. To combat inflation, the Federal Reserve began raising its benchmark interest rate in March 2022, bringing it from near-zero to more than 5% in a little over a year.
This approach has succeeded in the past, at great cost: almost every time the Fed has raised its interest rate to high levels, a recession has followed.
In September, billionaire Barry Sternlicht complained in an interview on CNBC that the Fed was “attacking the economy with a sledgehammer,” noting that the housing market had stalled amid higher mortgage rates, and predicted a widespread downturn and job losses.
Yet, those mass job losses have yet to materialize, defying the historical pattern.
Federal Reserve Chair Jerome Powell said at a May 3 press conference he still expects the economy to avoid the worst.
“It wasn’t supposed to be possible for job openings to decline by as much as they’ve declined without unemployment going up,” he said. “It just seems that, to me, that it’s possible that we can continue to have a cooling in the labor market without having the big increases in unemployment that have gone with many prior episodes.”
In addition to unemployment being at record lows, income is healthy as well: after being adjusted for inflation, household incomes, not counting money given to individuals by the government, grew 1.2% in April compared to the previous year.
And consumer spending, while showing signs of slowing, is still going strong according to recent data. For example, retail sales in April were up 3.1% over April 2022, data from the Census Bureau showed last week.
“There is broad strength in job markets, there is broad strength in consumption, there is broad strength in income growth,” Case said. “Those are the three pillars of the macroeconomy.”
There are still many threats to that continued prosperity.
Shoppers grappling with high inflation and squeezed by high borrowing costs on loans, are spending down the savings they built up in the pandemic and may be forced to curtail spending. That’s ominous for the economy because consumer spending is the main engine of economic growth, accounting for 68% of the gross domestic product.
Furthermore, banks have gotten more defensive and made credit harder to get, which makes life even more difficult for businesses and individuals trying to take out the loans that keep the economy humming.
The Fed’s track record of raising interest rates without causing a recession is poor, according to a March 2022 report by economists at Piper Sandler, who found that out of the last nine times the Fed raised rates, a recession ensued eight times, and only in 1994 did the Fed actually pull off anything like a soft landing.
Bond trading data has also contributed to recession fears. The yield curve, which compares yields on long-term versus short-term debt securities, shows that traders are currently expecting the Federal Reserve to be forced to cut interest rates in the near future in response to a recession.
While the yield curve and related indicators have a good track record of predicting recessions, they might not be as reliable as many economists suppose, Case argues. That’s because there has never been a soft landing from high inflation, so no one knows what the yield curve would look like ahead of that scenario.
“We've never had a soft landing, so it's simply impossible to forecast a soft landing directly,” Case said.
While many economists still expect a recession, it’s far from a sure thing. When the Wall Street Journal polled a panel of 62 economists in April, they put the odds of a recession in the year ahead at 61% on average, the same as they had said in January.
Michael Pearce, Lead U.S. Economist at Oxford Economics wrote in a commentary this week that he is forecasting a recession in the near future, but saw a growing chance of that being pushed back yet again or even canceled.
“Our baseline forecast is for a mild recession in the second half of the year, but we still think there's a possibility of a goldilocks scenario where the Fed returns inflation to its 2% objective without pushing the economy into a recession.”