It's getting murkier

As blog readers will know, a month ago, the UCLA Anderson Forecast was not predicting a recession.* It still isn't. However, Anderson forecaster Leo Feler does say the risk of recession has grown. From an email he circulated yesterday:

ECONOMIC UPDATE WITH LEO FELER

Are we headed for a recession? It’s becoming more likely. The Fed has signaled it will keep raising its benchmark interest rate until data shows that inflation has come down. Only one FOMC member, Esther George, voted against raising rates 75 basis points at the June FOMC meeting, citing concerns about forward guidance and how such an increase would affect households and businesses. Even traditionally dovish FOMC members, like Mary Daly, have turned hawkish. We expect the Fed to increase rates another 75 basis points at its July 26-27 meeting and continue raising rates up to at least 3.50–3.75% by the end of the year. We expect 30-year mortgage rates to remain at approximately 5.5%–6.5% throughout the remainder of 2022 and into mid-2023, which should substantially slow the housing market.

• Because of continued high inflation and the Fed’s actions to slow the economy, we now expect slower growth compared to what we forecasted at the end of May. Real GDP growth in Q2 2022 and for the remainder of the year is likely to be weak as the Fed continues to tighten monetary policy.
• Commodity prices, including oil, have started coming down, so there are some signs inflation may have peaked, and even gas prices at the pump might start easing. Still, inflation is likely to remain stubbornly high and inflation expectations, measured by 5-year breakevens** remain elevated, above 2.5%, as shown in Figure 1. Our forecast for quarterly CPI inflation, at seasonally adjusted annual rates, is shown in Figure 2.

 

Figure 1 (above): Market Expectations for Average Inflation During the Next Five Years

Source: Federal Reserve Bank of St. Louis FRED, available at: https://fred.stlouisfed.org/series/T5YIE.

    

Figure 2 (below): UCLA Anderson Forecast for CPI Inflation, Quarter-on-Quarter Percent Change in CPI, Seasonally Adjusted Annual Rates

Source: Bureau of Labor Statistics and UCLA Anderson Forecast.

  

• How can the economy be slowing when employment growth remains strong? And can the economy contract even as employment continues to grow? Actually, changes in employment tend to lag changes in output. Employment often peaks in the middle of recessions, not necessarily before recessions start, as shown in Figure 3. Because hiring and firing is costly, it takes time for businesses to lay off workers in response to a decline in demand. Businesses first tend to pause hiring, then they reduce workers’ hours, and only once there’s more certainty that a sustained decline in demand is occurring do they tend to lay off workers. It’s not inconsistent for employment to keep growing – but at a slower rate – even at the beginning of recessions.

 

Figure 3: Total Nonfarm Employment and Recessions (Shaded)

Source: Liz Ann Sonders, https://twitter.com/LizAnnSonders/status/1544654735080308736.

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*http://uclafacultyassociation.blogspot.com/2022/06/ucla-anderson-forecast-says-not-to.html.

**"Breakevens" are comparisons between ordinary U.S. Treasury bonds of a particular duration and inflation-adjusted U.S. Treasury bonds of the same duration. The difference in return is an implicit forecast of inflation over that duration.

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Editorial Note: First-quarter real GDP was estimated to have dropped. We are awaiting the official second-quarter estimate. So far, however, as measured by the latest unemployment rate (June) that was released today, the labor market has not show signs of a downturn although employment is still below its pre-pandemic peak. The latest unemployment rate and other associated estimates are always at https://www.bls.gov/news.release/pdf/empsit.pdf.