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Market stays resilient while Fed predicts recession

The question of whether a recession will finally happen remains the main theme for financiers and economists. Indeed, for the last two years, the word “recession” became perhaps the most pronounced word among professional economists. We are all expecting it, and yet, it has not happened. Despite better-than-expected consumer spending recently, the Federal Reserve forecasted a recession to take place later this year. According to Fed economists, the recession expected to happen shall be mild rather than severe.

U.S. Recession Probability

Source: Conference Board

The Fed’s prediction of a recession is based on the bank turmoil that happened last month. According to JP Morgan Chase CEO, Jamie Dimon, the banking crisis is not yet over. That forecast has led Fed officials to envision fewer interest-rates hikes this year, out of concern that banks will reduce their lending and weaken the economy. The most recession probability estimates, based on the Conference Board’s probability model near 99% pointing to the likelihood of a recession in the United States within the next 12 months. While the US GDP growth defied expectations in late 2022 and early 2023 data has shown unexpected strength. Despite the economy performing rather well, the Federal Reserve’s interest rate hikes and tightening monetary policy will lead to a recession in 2023.

In predicting the recession, the Federal Reserve emphasized the word “mild.” Why “mild”? The Fed assumes that the economy will experience pain but that pain will not be that of 2008 or even 1929 whereby people lost everything. Higher interest rates have also contributed to recession fears, with market veterans like David Rosenberg saying the central bank would be wrong to make any more rate hikes.

Fed Balance Sheet since January 2022

Source: U.S. Board of Governors of the federal Reserve

The real problem here is that we have a resilient market while the Fed continues to hike interest rates. The resiliency of the market is a signal that perhaps the Feds should pause rate hikes and let the market rally. The Federal Reserve is deliberately applying quantitative tightening to bring inflation down. In applying quantitative tightening, the Fed outright sells government bonds in the secondary Treasury market. The other way is to not buy back the bonds that the Fed holds when they mature. Thus, both methods of implementing QT would increase the supply of bonds available in the market. Hence, the main focus is on reducing the amount of money in circulation to contain the escalating inflationary forces. We can expect the Federal Reserve to hike once more interest rates in May. This forthcoming hike will possibly trigger the recession but not immediately. There is also the possibility that the forthcoming hike may still have no effect on the market, and the market continues to stay resilient. But this depends on how much will the Fed be ready to hike rates in May.

According to the Federal Reserve, the expected recession will take about two years to recover. The Fed’s staff economists added that they expected the US economy would fully recover by 2025. To determine whether or not there is a recession, the Fed looks for a significant decline in economic activity spreading across the economy, lasting more than a few months. The committee considers a wide range of indicators with particular emphasis on payroll employment and several measures of domestic production and income, such as GDP, gross domestic income, and industrial production. The expected economic recession could result in higher unemployment. Isn’t what the Fed wants? Jerome Powell made it clear that he would do anything to bring inflation down. This implies reducing inflationary pressures at the expense of deliberately creating unemployment, which will hurt mostly the middle class. The Fed has a few weeks to change its mind on rate hikes before its May meeting.


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