“We think the effects of higher interest rates are finally having the expected effect of slowing the US economy We see increasing signs in the labour market, including a rising unemployment rate and continuing jobless claims, that suggest hiring will slow.” - Citibank economist.

(Dec 21): A small cadre of Wall Street economists who’ve been surprised by the economy’s resilience in 2023 are doubling down on expecting pain for American households and businesses in the new year.

Forecasters at Citigroup Inc, Deutsche Bank AG and Wells Fargo Securities LLC are among those reiterating predictions for a recession, even as the Federal Reserve and most on Wall Street are looking for slower but still-positive growth in 2024.

The pessimistic case: Consumers, whose spending comprises about 70% of economic activity, are running out of savings built up during the pandemic and face headwinds including student-loan repayments and a cooling job market. The impact of the Fed’s most aggressive interest-rate increases in 40 years has merely been delayed, and tighter credit conditions will pose difficulties for borrowers forced to refinance debts.

Even so, the bears say the downturn won’t be ugly like the Covid-induced one in 2020 — when unemployment soared to nearly 15% — or last long, like the 2007-2009 decline. US stocks have surged and Treasury yields have plunged in the past two months as inflation has receded and Fed officials penciled in rate cuts for 2024, leading much of Wall Street to celebrate good tidings.

“It barely qualifies as one, but yes, technically it would be a recession,” Brett Ryan, a senior US economist at Deutsche Bank, said of his forecast for a mild downturn. “The risks, especially in light of a dovish Fed, are that we don’t get as much of a slowdown. Financial conditions right now are easing pretty considerably, and that introduces upside risk to our forecast.”

Citigroup also cites the Fed’s pivot as improving the outlook, though economists led by Andrew Hollenhorst still see a slump.

“We think the effects of higher interest rates are finally having the expected effect of slowing the US economy,” he said. “We see increasing signs in the labour market, including a rising unemployment rate and continuing jobless claims, that suggest hiring will slow.”

Weakness in the labour market will eventually trigger a decline in consumer spending, according to Sam Bullard, a senior economist at Wells Fargo Securities. So far, he’s been surprised by the economy’s resilience, and expects the 2024 downturn to be “certainly mild by historical standards”.

“We would fully admit that there’s certainly a path where a recession doesn’t unfold: We continue to moderate, but yet don’t hit the technical definition of a recession,” he said.

In the US, a group of elite economists at the National Bureau of Economic Research’s business cycle dating committee, led by Stanford University’s Robert Hall, makes the official calls in dating the timing of recessions, based on factors including employment, consumer spending and other data.

Already underway

According to Bloomberg Economics, a recession may already be underway. Anna Wong, Bloomberg’s chief US economist, cites the rapid deterioration in the anecdotes from the Fed’s business contacts reported in the central bank’s “Beige Book” survey, a loosening in the labour market, and the Fed’s pivot towards rate cuts.

“A lot of typical signs that show at the start of a recession showed up in October,” she said. “We think a downturn likely has happened and we still believe that.”

Nonetheless, the pessimist camp is dwindling. A year ago, economists surveyed by Bloomberg put recession odds at 70% and were slashing growth forecasts. In March, the Fed’s own staff economists followed suit.

By July, Fed chair Jerome Powell told reporters at a press conference that the staff had ditched its call and was instead embracing predictions of a soft landing. That was followed by similar moves from Bank of America Corp, JPMorgan Chase & Co and Barclays plc.

Goldman Sachs Group Inc consistently went against the tide, arguing there would be a surge in household disposable income and a strong labor market this year with no downturn.

Growth accelerated during the year and was a robust 5.2% in the third quarter, while fourth-quarter gross domestic product was tracking an above-trend 2.7% as of Dec 19, according to the Atlanta Fed’s estimate.

“We were arguing that the key risk to the economy was reacceleration, not recession,” said David Mericle, chief US economist at Goldman. “We certainly didn’t get everything right, either” as growth came in even stronger than the team expected, he said.

The economic optimists are also skeptical of the idea that monetary policy has “long and variable lags” in its impact on businesses and consumers, disputing that the pain has simply yet to materialise.

“I think it’s ridiculous,” Neil Dutta, director of economic research at Renaissance Macro Research LLC, said of the pessimists. “What’s their story? That higher rates have almost no impact at first and then all of a sudden the economy just spontaneously combusts? That’s not consistent with empirical research.”