Big banks predict an economic downturn is fast approaching.
More than two-thirds of economists at 23 major financial institutions that do business directly with the Federal Reserve are predicting a 2023 US recession. Two others are predicting a 2024 recession.
The firms known as primary dealers are a collection of trading firms and investment banks that include such companies as Barclays PLC, Bank of America Corp., TD Securities and UBS Group AG. They cite a number of red flags: Americans are spending their pandemic savings. The housing market is declining and banks are tightening their lending standards.
“We expect a slowdown in global GDP growth in 2023, led by recessions in both the US and the eurozone,” economists at BNP Paribas SA wrote in the bank’s 2023 Outlook, titled “Steering into Recession”.
The main culprit is the Federal Reserve, economists said, which has been raising interest rates for months to try to slow the economy and curb inflation. Although inflation has eased recently, it is still much higher than the Fed’s desired target.
The Fed hiked rates seven times in 2022, raising its benchmark from a 0% to 0.25% range to the current 4.25% to 4.50%, a 15-year high. Officials signaled in December that they plan to raise interest rates to between 5% and 5.5% by 2023.
Most of the economists polled by the Wall Street Journal expect the higher rates will push the jobless rate to over 5% from 3.7% in November — still low by historical standards, but it would likely result in millions of Americans losing their jobs lose their job.
Most also expect the US economy to contract in 2023.
Although the economy has held up relatively well during the 2022 rate hikes — jobless claims remain low, for example — economists said the cooling effects of higher interest rates will be more noticeable in 2023. US interest rates are still well below historical levels, but are the highest since 2008, before the global financial crisis.
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Of course, almost everyone on Wall Street and in Washington got 2022 wrong – from the Fed’s claim that inflation would be temporary to top Wall Street analysts forecasting a mundane year of growth for stock and bond prices . The extent to which investors, analysts and economists have been caught off guard has many feeling uneasy about the year ahead.
Still, economists and money managers are pointing to a number of indicators that traditionally point to recessions: banks have tightened lending standards and demand has weakened to levels typically associated with recessions. The Conference Board’s collection of leading economic indicators has fallen for nine straight months, reaching levels that have preceded recessions in the past. And indicators tracking broader business activity, services and manufacturing sectors have fallen to some of the lowest levels since the 2020 Covid-induced recession.
In addition, US Treasury bonds with maturities between three months and two years have higher yields than bonds with maturities of 10, 20 or 30 years. This so-called inverted yield curve is a warning sign that has occurred before every US recession since World War II.
The excess savings Americans tucked away at the height of the pandemic has shrunk from about $2.3 trillion to $1.2 trillion, according to the Fed. Analysts at Deutsche Bank assume that this will be fully exhausted by October.
“Consumer demand is slowing and we believe it will slow sharply as excess savings begin to run dry and consumers become more stressed,” said Brett Ryan, senior US economist at Deutsche Bank. Companies will also likely need to scale back capital expenditures, Ryan said.
Sure, a majority of economists who expect the US economy to contract are forecasting a “shallow” or “mild” recession. They expect the economy and US stock markets to recover in late 2023, largely due to the Fed turning to rate cuts. They largely expect bonds to deliver strong returns in 2023, while stocks end the year slightly up.
Most forecasts assume that the Fed will hike rates in the first quarter, pause in the second, and start cutting rates in the third or fourth quarter.
They expect the Fed’s pivot to bring heightened volatility to the stock market but overall deliver mediocre returns. Average outlook targets put the S&P 500 about 5% higher than its current level at the end of 2023. Some are calling for the S&P to fall from its current level by the end of 2023, including Barclays and Société Générale SA.
“Stocks look very rich,” said Steven Abrahams, senior managing director at Amherst Pierpont. “It’s an easy decision to allocate from stocks to bonds.”
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Only five of the 23 financial institutions surveyed by the Journal said they expect the US to avoid a recession in 2023 and 2024: Credit Suisse Group AG, Goldman Sachs Group Inc., HSBC Holdings PLC, JPMorgan Chase & Co. and Morgan Stanley.
“Several historically reliable leading indicators are sending signs of recession, but in our view these metrics are inadequate to properly assess the risk of a recession in the current environment,” wrote Jeremy Schwartz, senior U.S. economist at Credit Suisse, in the bank’s 2023 Economic Outlook.
But even these relatively optimistic economists are predicting that the US economy will grow much more slowly than it has over the past 20 years.
They expect growth to slow to about 0.5% on average for the year. The economy grew at an average rate of 2.1% from 2012 to 2021.
Goldman has the rosiest outlook for 2023, forecasting US gross domestic product growth of 1%.
US Treasury yield curve inverted hits extreme new levels. But paradoxically, this could suggest that investors are both more and less concerned about a recession. WSJ’s Dion Rabouin explained. Illustration: David Fang
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