Wall Street vastly underestimates recession risk, economist warns

The Fed is not likely to stop the bleeding in time, according to experts
By Sam Bourgi
•
31 May 2024
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Wall Street bull

Wall Street is becoming more confident in the Fed’s ability to orchestrate a “soft landing,” but not everyone is convinced.

Bloomberg editor Edward Harrison said last week that the probability of recession is much higher than economists think. He even called it a looming "black swan event."

Harrison pointed to the uptick in the three-month average U.S. unemployment rate, the growing odds of corporate credit downgrades, and signs of a stressed-out consumer as red flags.

Some may disagree with Harrison’s argument.

After all, the unemployment rate remains near historic lows at 3.9%, and employers continue to add hundreds of thousands of jobs each month.

“[R]ecessions aren’t about how low the unemployment rate is. It’s about how much things unravel such that people start cutting back on spending,” Harrison explained.

“In fact, the unemployment rate is always at its lowest right before a recession almost by definition,” he said.

Harrison showed that, outside of Covid, the 0.34% uptick in unemployment is the largest since 2010 when the U.S. was recovering from the financial crisis.

Other economists, such as Wendy Edelberg of the Brookings Institution, have cited a sharp rise in immigration as a reason for the recent string of positive job data.

But, as Fed Chair Jerome Powell admitted, that just means “it’s a bigger economy, not a tighter one.”

The Fed has no reliable framework

If the economy continues to slow, as it did in the first quarter, and dips into a recession, the Fed is not likely to stop the bleeding in time, according to experts.

That’s because the U.S. central bank is razor-focused on fighting inflation instead of taking a more nuanced approach to balancing its priorities.

According to Allianz chief economist Mohamed El-Erian, the question is not whether the Fed will “flip-flop” again on its priorities but whether it will do so in time.

“The critical question is whether this occurs in time to avoid significant economic and financial damage, particularly to the most vulnerable segments of the population,” he said.

Nobel Prize-winning economist Joseph Stiglitz agrees. According to him, the Fed is too focused on an arbitrary 2% inflation target, losing touch with the broader economy.

“The Fed’s response of just raising interest rates wasn’t getting at that underlying source and in some ways made things worse,” he told CNBC earlier in May.

The Fed voted to leave interest rates unchanged at its last policy meeting and is expected to do so again in June. Markets are pricing in a reasonable chance of a rate cut sometime in the fall.

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