Economists Growing Divided on Forecast for Recession – Here’s Why

(August 9, 2023) — Even as hopes rise for an economic soft landing following the Fed’s aggressive rate hikes, Wells Fargo economists said Monday that they’re sticking with their call for a mild recession in early 2024.

“Economists are growing broadly divided on the prospects of a near-term recession,” Wells Fargo economists Azhar Iqbal and Nicole Cervi told clients Monday. Those divisions were on full display last week, with several banks overhauling their forecasts, based on stronger economic data.

Bank of America Global Research said Aug. 2 that it expects a soft landing for the economy and boosted its U.S. growth outlook based on how well the economy is performing. Arizona’s third-largest bank no longer expects a mild recession in 2024 and expects real economic growth this year to reach 2% on average, up from its prior forecast of 1.5%.

JPMorgan’s Chief U.S. Economist Michael Feroli said Aug. 4 that the bank, the largest in Arizona ranked by local deposits, is also no longer expecting a recession to hit this year. The bank expects the current quarter’s real economic growth to come in at an annualized rate of 2.5%, up from an earlier forecast of just 0.5%, Reuters reported.

Three’s a Trend for Wells Fargo

Last year, Wells Fargo economists released a three-report series entitled Is Recession Coming? that outlined a couple methods to predict recessions and monetary policy pivots. The economic landscape has shifted since it published that series—the fundamental components of the economy have performed better than anticipated in recent months despite the aggressive pace of policy tightening from the Federal Reserve. Economists are growing broadly divided on the prospects of a near-term recession, so we take this opportunity to update and revisit the series’ major tools.

The first tool is the preferred Probit method, which is based on the Leading Economic Index, the S&P 500 and the employment component of the ISM manufacturing index. The method estimates that the probability of a recession fell to 52% in Q2, down from 55% in Q1 (Figure 1). While the probability has slipped, it has been above 50% in four of the past five quarters. Historically, when this Probit’s probability has surpassed 50%, the economy experienced a recession within the next four quarters. In short, our Probit framework suggests that recession within the next year is still more likely than not.

The second tool is the spread on the 10-year and 1-year Treasury yields. The Wells economists also point to the widely followed yield-curve inversion, which assesses the spread between the 1-year and 10-year treasury. Typically, the 10-year yield is higher than the 1-year as investors assume more risk over the longer maturity. The spread between the 1- and 10-year treasuries has been negative for 13 consecutive months (Figure 2), as of July, “signaling a recession is indeed on the horizon,” the two economists said.

The Wells economists said they have found that when the federal funds rate crosses the lowest 10-year Treasury yield, that a Fed pivot in monetary policy is likely within 18 months of that crossing. In the current cycle, that crossing occurred in March 2022 — 16 months ago — when the Fed kicked off the latest rate hikes.

The final tool is a threshold method that uses the 10-year Treasury yield and the federal funds rate (FFR). In a rising interest rate environment, we found that when the FFR crosses the lowest 10-year yield in that cycle (the threshold), a monetary policy pivot is likely to ensue in the next 18 months. As shown in (Figure 3), the FFR crossed the 10-year’s current cycle low back in March 2022, when the FOMC kicked off its tightening cycle. The FOMC decided to hold rates steady in June, 16 months following the threshold breach. While the FOMC elected to hike the FFR by 25 bps to a target range of 5.25%-5.50% in July, the threshold approach suggests to the Wells economists that such a pivot move usually occurs amid slowing economic growth.

In sum, all three tools signal a recession within the next year according to Wells Fargo economists. Despite the odds of a soft landing rising amid resilient economic data, the framework aligns with Wells base case expectation for a mild recession in early 2024.