Fed Staff Now Sees Recession Coming
Now we know why Federal Reserve officials at the March meeting yanked down their expectations for economic growth for this year and next: the economics staff of the central bank warned that a recession is on the way.
The official Summary of Economic Projections (SEP) released at the end of the last meeting of the Federal Open Market Committee (FOMC) showed that the median expectation for fourth-quarter to fourth-quarter economic growth had fallen to 0.4 percent for 2023, down from the December expectation of 0.5 percent, and dropped to 1.2 percent for 2024, down from 1.6 percent.
To put that in further context, at the September FOMC meeting, the median expectation was for 1.2 percent this year, and it was as high as 1.7 percent at the June meeting. The 2024 growth projection in September was for 1.7 percent, and in June it was for 1.9 percent, basically in line with the Fed’s estimate for the long-term rate of growth of 1.8 percent.
The Fed also reports what it calls the “central tendency” of the projections. This trims off the top three and bottom three projections. At the March meeting, the central tendency for GDP growth was for 0.0 percent to 0.8 percent this year and 1.0 percent to 1.5 percent next year. At the prior meeting, it had been 0.4 percent to 1.0 percent for 2023 and 1.3 percent to 2.0 percent next year.
The Early Tell of Fed Recession Predictions
When the new SEP came out in March, we explained that the “Federal Reserve appears to expect economic growth to come crashing to an abrupt halt later this year.” Our reasoning was straightforward (although it was not widely accepted when we said it): with the economy apparently growing somewhere around a two percent rate in the first quarter, it would take a severe slowdown or recession to bring the full-year growth rate down to 0.4 percent.
“So, in order to get just a 0.4 percent growth for the year, we very likely will have to experience one or more quarters of negative real growth. The paucity of the rebound forecast for the following year suggests that the Fed expects us to start next year in contraction,” we wrote.
The minutes from the FOMC meeting have now confirmed that this is exactly what Fed officials had in mind when they downgraded their expectations for gross domestic product growth.
Here’s what the Fed staff said to FOMC participants:
For some time, the forecast for the U.S. economy prepared by the staff had featured subdued real GDP growth for this year and some softening in the labor market. Given their assessment of the potential economic effects of the recent banking-sector developments, the staff’s projection at the time of the March meeting included a mild recession starting later this year, with a recovery over the subsequent two years. Real GDP growth in 2024 was projected to remain below the staff’s estimate of potential output growth, and then GDP growth in 2025 was expected to be above that of potential. Resource utilization in both product and labor markets was forecast to be much less tight than in the January projection. The level of real output was projected to move below the staff’s estimate of potential output in early 2024, more than a year sooner than in the previous projection. Likewise, the unemployment rate was projected to rise above the staff’s estimate of its natural rate early next year. [Emphasis added]
This was a change from the February minutes. Back then, the baseline was not for a recession, although the staff noted it was a risk.
“The sluggish growth in real private domestic spending expected this year and the persistently tight financial conditions were seen as tilting the risks to the downside around the baseline projection for real economic activity, and the staff still viewed the possibility of a recession sometime this year as a plausible alternative to the baseline,” the February minutes reported [Emphasis added].
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We also noticed that the February minutes reported that market participants were more wary of a downturn that the Fed staff.
“While most Desk survey respondents expected subdued growth or a mild recession in 2023, market participants continued to see notable uncertainties ahead, including prospects for a deeper downturn or the potential for more persistent inflation,” the February minutes reported.
Notably, the March minutes did not include an assessment by market participants about the prospects for a downturn or a recession.
Fed Officials More Worried About Inflation Than Staff
While the Fed staff’s deployment of the dreaded-R word attracted a lot of attention this week, the divergence between the staff and FOMC participants when it comes to inflation as measured by the Personal Consumption Expenditure (PCE) price index should also be noted.
The February minutes explain that “[o]n a four-quarter change basis, total PCE price inflation was forecast to be 2.8 percent in 2023, and core inflation was expected to be 3.2 percent, both lower than in the December projection.” In the March minutes, this year’s headline PCE price inflation forecast is still reported to be 2.8 percent, but core inflation is moved up to 3.5 percent.
Fed officials, however, have not moved down their headline expectation for 2023 headline PCE inflation. In fact, the opposite happened. The median projection for PCE price inflation moved up from 3.1 percent at the December meeting to 3.5 percent at the March meeting. And the FOMC officials raised their median forecast for core inflation to 3.6 percent.
In other words, the Fed officials appear to be more worried about persistent inflation than the staff.