The first major Wall Street bank to forecast a recession now sees its own pessimistic view of downside risk

Deutsche Bank, the first major Wall Street bank to call for a US recession during the current high-inflation era, is now looking at a limb: its own outlook for downside risks, given the likelihood of persistently elevated price gains and Continued upside surprises.

Describing themselves as “the extreme outlier on the street,” researchers at the German bank have an official house call for a “mild” US contraction late next year, as the Fed pushes forward with hiking rates and shrinking its balance sheet to combat inflation. – Putting Deutsche Bank at the Pessimistic End of 75 Forecasters Surveyed by Bloomberg. However, they say, an even deeper recession may be needed to bring the inflation under control.

Contributing to the likelihood of continued upside surprises, more than four years on, the developments were already under way before the pandemic, like climate change and a reversal of globalization, Deutsche Bank’s researchers said in a release. on Tuesday. They also said that wages are likely to keep up with the tight labor market, and that inflation expectations should rise in the year ahead.

On top of all this is a dramatically shifting inflation psychology, which includes selling goods and services that are willing and able to increase costs and buyers willing to accept them, and the notion that even an aggressive Federal Reserve policy response will not be enough. to Deutsche Bank. Its researchers said they would not be looking at the core personal-consumption expenditures price index, the Fed’s preferred measure, at which 4% to 5% well into a recession hit the next year.

“Our house view is that a mild US recession is a couple of quarters of negative growth, and unemployment is going up 1 to 1.5 percentage points,” said Peter Hooper, global head of economic research. “A severe recession, which we saw in 2008 and in the early 1980s, is a very different animal: something that lasts a year, a year and a half, and has unemployment going up by 5 to 6 percentage points.”

“The recession we have in mind is that our house call is somewhere between two: one lasting several quarters, with a significant drop in GDP and unemployment going up by 3 percentage points, but not enough to turn to inflation psychology,” he said. Hooper told MarketWatch in a phone interview Tuesday.

Broadly speaking, professional forecasters and policy makers alike have proven consistently wrong underinvesting in inflation – a measure of the headline annual rate of the consumer-price index, which hit 5% last May and has been climbing ever since. A survey by the National Association for Business Economics found earlier this month that nearly half of the 84 respondents saw a 25% or lower probability of a US downturn in the next 12 months.

Some economists see a recession as likely, though not as often as 2024 or beyond. Jefferies LLC noted that all 10 US recessions in the past 70 years were preceded by Fed rate hikes, but it took a few years to materialize.

Read: Are recession worries overblown? Here’s why a downturn appears far off

The chart below shows how far Deutsche Bank’s CPI forecast, as reflected in the light blue dotted line, is from the rest of the pack.

Sources: Bloomberg LP; BLS; Deutsche Bank

Now, policy makers are assuming they can achieve a “soft landing” in which inflation comes down and unemployment steadily increases as they begin to raise the Fed-funds rate target by a larger-than-normal 50 basis point increase. , starting in May, from its current level of 0.25% and 0.5%. Activist investor Carl Icahn is one of those who have a safe-landing assumption against a pushed back.

Washington Watch: Yellen says the US economy for Fed to engineer soft landing

The most important factor behind Deutsche Bank’s view is that the likelihood of inflation will be higher than expected, according to David Folkerts-Landau, chief economist and head of research; Hooper; and Jim Reid, Head of Thematic Research. They wrote that the only way to minimize the economic, financial and societal damage of prolonged inflation is to “do too much on the side of err.”

‘It’s rare that we have this much advance warning: we have a significant inflation problem and historically the Fed has been able to deal with this kind of inflation problem without a significant downturn.’

– Peter Hooper, Deutsche Bank

They see the Fed’s main policy-rate target going above 3.5%, with a shrinking balance sheet contributing to the equivalent of tightening in another half percentage point, and a US recession occurring in “late 2023 / early 2024.” Moreover, the researchers see the euro area slowing near recession in early 2024, with the European Central Bank also saying that the inflation problem is “not far behind.”

“What surprises us is that our house is called a consensus,” Hooper told MarketWatch. He says that for one reason it may be persistently high inflation is a “recent and sudden development.”

Two more possible reasons, he said, are that “the Fed has yet to acknowledge the potential risks of unemployment, and the timing of a recession is never as easy and as often as not done.” Still, “It’s rare that we have this much advance warning: we have a significant inflation problem and historically the Fed has not dealt with this kind of inflation problem without a significant downturn.”

Deutsche Bank became the first bank to forecast a recession during the current inflationary era earlier this month, when it revised its global growth forecasts to partly due to war in Ukraine.

While shutdowns in parts of China are likely to add to inflation pressures, Hooper said he expects the country to perform better next year.

On Tuesday, US stocks DJIA,
+ 0.19%

+ 0.21%
fell sharply. with the Nasdaq Composite COMP,
down more than 3% during the final hour of trading. Treasury yields were also broadly lower with the 10-year rate TMUBMUSD10Y,
hovering below 2.76%.

This report was contributed by Jeffry Bartash.


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