Stephen Roach, a senior fellow at Yale University, holds that it will be difficult for the United States to avoid a recession next year as the Federal Reserve (Fed) wrestles with inflation and the economy faces pain from prolonged policy tightening.
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"As the lags of the recent and coming Fed tightening kick in, it would be nothing short of a miracle if the U.S. were to avoid recession," he said, adding that "the likelihood of dodging a recession through a rare soft landing is low."
Roach, also former chair of Morgan Stanley Asia and the firm's chief economist, said the two sequential declines in U.S. quarterly real gross domestic product (GDP) in the first half of 2022 were "especially worrisome."
While the economy rebounded a bit in the third quarter, the average annual growth rate for the first three quarters of this year was anemic, "a weakening that has already taken a stalling U.S. economy to the brink of outright recession."
As the Fed ups the ante on its recent tightening campaign, the stall should give way to a more classic recession, noted Roach, adding "a U.S. recession is likely in 2023."
The U.S. central bank has been raising interest rates since March, including hiking 75 basis points at each of its last four consecutive meetings and is widely expected to deliver an additional 50 basis point increase when concluding a two-day meeting on Wednesday, in a bid to tame record inflation.
While it seems reasonable to presume that the U.S. may have hit its peak inflation rate for this cycle, "post-peak inflation remains unacceptably high, with the year-over-year headline consumer price index (CPI) rising by an average of 8.1 percent over the three months ending October," he said, noting that "the anti-inflation resolve of the Fed will continue to be tested in the months and quarters ahead."
The Fed still has some ways to go in its inflation fight, especially when analyzing the inflation-adjusted federal funds rate, or real federal funds rate, his preferred metric that compares the nominal federal funds rate and the three-month average of the headline CPI.
The inflation-adjusted federal funds rate "remains sharply in negative territory," with around -3.8 percent in real terms in November. Yet, the long-term average of the real federal funds rate since 1960 stood at 1.1 percent, which is also "a reasonable approximation of a 'neutral' policy stance.
"That means the Fed will still have to conduct a major additional tightening operation to get its policy rate into the restrictive zone that Fed Chair Jerome Powell signaled," said Roach, given the fact that restrictive should be a number greater than neutrality.
"The upside to U.S. interest rates remains a considerable risk to the downside of the U.S. business cycle," he warned. The Yale scholar also sounded the alarm over a global recession and its market implications.
"My best guess is that the world will tip into a global recession by late 2022 or early 2023," he said, noting that the global equity markets may not have hit the lows that would be consistent with the coming global recession. "Currency and equity market volatility may well be here to stay for the foreseeable future," he added.