The US faces ‘L-shaped’ recession as Fed scrambles to tame inflation: analyst

The US economy will likely have to stay in recession for longer than anticipated in order to bring runaway inflation under control, according to a top analyst.

Zoltan Pozsar, the global head of short-term interest rate strategy at Credit Suisse Group AG, wrote a client note pushing back on widespread sentiment that the worst of inflation may be behind us and that the Federal Reserve will begin lowering interest rates.

Instead, the US may have to gird for a so-called “L-shaped” recession that will be deeper and longer than expected, according to Pozsar.

Pozsar cited the ongoing Russian invasion in Ukraine as well as disruptions to the supply chain exacerbated by intermittent COVID-related lockdowns in China.

Consumer price inflation is running at a 12-month rate of 9.1%, its highest since November 1981. Even throwing out the highs and lows of inflation, as the Dallas Fed does with its “trimmed mean” estimate, inflation is running at 4.3%.

Data overnight showed US real GDP declined 0.9 per cent in the June quarter following a 1.6 per cent drop in the March quarter, below the consensus expectations of growth of 0.4 per cent.

“The second consecutive quarterly decline in real GDP marks the beginning of a technical recession, but an official recession depends on broad weakness across labour markets, industrial production and other indicators,” said Nomura India.

St. Louis Federal Reserve President James Bullard said Wednesday that the central bank will continue raising rates until it sees compelling evidence that inflation is falling.

The central bank official said he expects another 1.5 percentage points or so in interest rate increases this year as the Fed continues to battle the highest inflation levels since the early 1980s.

The rate hikes come at a time of slowing growth in the U.S., which has seen consecutive quarters of negative GDP readings, a common definition of recession. However, Bullard said he doesn’t think the economy is really in recession.

“We’re not in a recession right now. We do have these two quarters of negative GDP growth. To some extent, a recession is in the eyes of the beholder,” he said. “With all the job growth in the first half of the year, it’s hard to say there’s a recession. With a flat unemployment rate at 3.6%, it’s hard to say there’s a recession.”

Why a recession could be consumer-led

Even with the latest data, consumer spending has been pretty flat for the past seven months, according to Jonathan Pingle, chief U.S. economist at UBS.

At the start of the year, households were in good shape with excess savings and solid labor market gains. But then high gas prices and rising interest rates were piled on.

“Altogether, it’s just proven to be a much weaker trajectory for consumer spending than I think most people expected,” Pingle said. “Where we sit now is kind of in a tenuous spot for the economy.” 

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