Will the Fed's rate hikes lead to a recession?

The Federal Reserve raised rates to 1.0% at the end of April, and our analysts currently see up to 225 basis points of additional tightening by the end of the year, with a Consensus of plus 127 basis points. If the higher forecasts are realized, this would take the Fed’s policy rate back to levels not seen since before the 2008 financial crisis.

Right now, economic conditions are still sound: In April, the economy added over 400,000 jobs, while service sector activity grew faster than the historical average according to PMI data. Plus, the falls in both headline and core inflation in April—if maintained—could reduce pressure on the Fed to accelerate its monetary tightening. Our panelists currently predict a return to GDP growth from Q2 on solid gains in private consumption and fixed investment, following a surprise contraction in Q1. No panelist currently pencils in a recession.

 

That said, the probability of a U.S. recession still stands at around 30% according to the latest Bloomberg survey—the highest level since 2020. Faster-than-anticipated Fed hikes would dampen lending and likely also weigh on the housing sector and the stock market. Given that over half of Americans have invested in stocks and that roughly two thirds own their homes, lower asset prices could weigh on household spending intentions through a wealth effect. Lockdowns in China and an economic slowdown in Europe could further dampen U.S. activity.

To sum up, our forecasts do not currently indicate an imminent recession in the U.S., but it’s all too easy to see how this picture could change

Insight from our analysts:

On the outlook for the U.S., Thomas Feltmate, senior economist at TD Economics, said:

“Even though modest, the deceleration in price pressures [in April] will come as a welcome development to policymakers. Still, the FOMC has its work cut out for them over the remainder of the year, as they quickly move to swing the monetary pendulum from accommodative to outright restrictive in an effort to guide inflation back to target without causing a recession.”

On rate expectations, Alvin Liew, senior economist at United Overseas Bank, said:

“We continue to expect the Fed Funds Target Rate (FFTR) to be hiked by 50 basis points in the June and July FOMC, which is now affirmed by the April CPI inflation report that showed services inflation is accelerating. We continue to expect 25 basis points [hikes] in every remaining meeting of this year. Including the March FOMC’s 25 basis point hike and last week’s 50 basis point hike, this upgrade now implies a cumulative 250 basis points of increases in 2022, bringing the FFTR higher to the range of 2.50–2.75% by end of 2022 (from our previous forecast of 200 basis points of hikes to 2.00–2.25% by end 2022).”

 

 

Disclaimer: The views and opinions expressed in this article are those of the authors and do not necessarily reflect the opinion of FocusEconomics S.L.U. Views, forecasts or estimates are as of the date of the publication and are subject to change without notice. This report may provide addresses of, or contain hyperlinks to, other internet websites. FocusEconomics S.L.U. takes no responsibility for the contents of third party internet websites.

Author: Oliver Reynolds, Economist

Date: May 20, 2022

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