What is Causing the Predicted Recession in 2023?

Recessions are often unpredictable and can take everyone by surprise. However, there is a good chance that the next recession will not be as much of a shock. By being aware of the signs of a recession, we can be better prepared for the next one.

‍
Most economists believe that the economy will enter a period of contraction in the near future. There is debate among experts about how deep and long-lasting the recession will be, but the general consensus is that a recession is coming.
"We've seen this story before," said Mark Zandi, chief economist at Moody's Analytics. "When inflation picks up and the Fed responds by pushing up interest rates, the economy ultimately caves under the weight of higher interest rates."

‍
Zandi is one of the few economists who believe that the Federal Reserve can avoid a recession by raising rates just enough to avoid squashing growth. However, he said that expectations are high that the economy will still falter. Zandi stated that recessions typically catch us by surprise. He noted that CEOs rarely discuss the possibility of a recession, but now it seems they are openly admitting that one is coming. Zandi remarked that he has never seen anything like it, with everyone from TV commentators to economists predicting a recession.

‍
The Federal Reserve is ironically slowing the economy, after coming to the rescue in the last two economic downturns. The central bank helped stimulate lending by taking interest rates to zero, and boosted market liquidity by adding trillions of dollars in assets to its balance sheet. The Fed is now unwinding that balance sheet, and has rapidly raised interest rates from zero in March - to a range of 4.25% to 4.5% this month.
In the last two recessions, the central bank did not have to worry about high inflation affecting consumer or corporate spending power, or spreading across the economy through the supply chain and rising wages.

‍
The Fed is now facing a serious battle with inflation. Central bank officials have forecasted that there will be more interest rate hikes in the future, up to about 5.1% by early next year. Economists also expect that the central bank may keep rates high after that in order to control inflation. The high interest rates are already having an impact on the housing market, with home sales down 35.4% from last year in November. This is the tenth month in a row of decline. The 30-year mortgage rate is close to 7%. Consumer inflation is still running at a high rate of 7.1% per year in November.

‍
Tom Simons, money market economist at Jefferies, has warned that the coming recession will be a classic one. He predicts that it will first manifest in corporate profit margins being squeezed, followed by companies cutting back on expenses by reducing headcount. This will lead to a slowdown in economic growth and lower inflation by the middle of next year. An economic recession is a prolonged period of economic decline. It is typically defined as lasting two quarters or more. The National Bureau of Economic Research (NBER) is the arbiter of recessions. The NBER considers the depth of the slowdown, how widespread it is, and how long it lasts.

‍
However, if any factor is severe enough, the NBER could declare a recession. For example, the pandemic-related downturn in 2020 was so sudden and sharp, with wide-reaching impact, that it was determined to be a recession even though it was very short.
Diane Swonk, chief economist at KPMG, said that she is hoping for a short, shallow recession. However, she noted that the good news is that the economy should be able to recover from it quickly. She explained that this is because the Fed induced recessions are not balance sheet recessions.

‍
The Federal Reserve's latest economic projections show the economy growing at a pace of 0.5% in 2023. However, the Fed does not forecast a recession in the near future.
"The Fed is trying to create a recession, and they'll succeed," said Swonk. "When you say growth is going to stall out to zero and the unemployment rate is going to rise, it's clear that the Fed has got a recession in its forecast. They won't say it, but it's coming." The Fed forecasts that unemployment could rise next year to 4.6% from its current 3.7%.

‍
The Federal Reserve's ability to keep interest rates at high levels is uncertain. Traders in the futures market expect the Fed to start cutting rates by the end of 2023. In its own forecast, the Fed shows rate cuts starting in 2024. Swonk believes that the Federal Reserve will eventually have to lower interest rates again due to the recession, but Simons expects that the recession could continue through 2024 in a period of high interest rates.

‍
Simons stated that the market believes the Federal Reserve will lower interest rates as the economy weakens. However, what is not understood is that the Fed needs to do this in order to maintain its credibility on inflation. Simons said that the last two recessions were caused by shocks, and that the pending recession will be nothing like that. He said that the recession in 2008 started in the financial system, and that the pending recession will be nothing like that.

‍
According to Simons, the financial crisis was caused by a lack of liquidity and trust in the markets, rather than by the Fed's policy of raising interest rates. He believes that the markets are not currently in the same precarious position they were in during the crisis.
In retrospect, the recession seemed longer than it actually was, according to Swonk. "It started in January 2008...It was like a year and a half," she said. "We had a year where you didn't realize you were in it, but technically you were...The pandemic recession was two months long, March, April 2020. That's it."

‍
The potential for recession has been looming for some time, but the Fed has yet to take any significant action to slow down employment or cool the economy. However, layoff announcements are increasing, and some economists believe that we could see declines in employment next year.

‍
Zandi said that at the beginning of the year, the economy was adding around 600,000 new jobs per month, but now that number has dropped to around 250,000. He predicts that job growth will continue to slow down, with employment actually declining next year. However, he doesn't believe this will be enough to cause a recession.
"It's ironic that everyone is expecting a recession," he said. That could change their behavior, and the economy could cool down. The Fed wouldn't have to tighten so much that it would choke the economy, he said.

‍
Zandi stated that debt service burdens are currently low, households have a lot of cash on hand, corporates have strong balance sheets, and profit margins are near record highs. He added that the banking system is well-capitalized and liquid, and every state has a rainy day fund. Finally, he noted that the housing market is currently underbuilt, which is usually a sign that a recession is not imminent.

‍
But Swonk said the Fed is not going to give up on the inflation fight until it believes it is winning. "The Fed is becoming more hawkish as the economy improves, which makes a soft landing less likely," she said.