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Recessionary fears in '22 overblown, Fed could overtighten


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Recessionary fears in '22 overblown, Fed could overtighten

While recessionary fears have grown on the Street, S&P Global Ratings U.S. Chief Economist Beth Ann Bovino does not see a downturn developing this year.

The broader markets have sold off heavily in recent months, and credit spreads have widened amid elevated inflation, geopolitical concerns over the war in Ukraine and COVID-19-mandated lockdowns in China, and the fear that the Federal Reserve's efforts to combat inflation could push the U.S. into a recession. Bovino said in the latest Street Talk podcast that uncertainty has increased but noted the U.S. job market remains strong and consumers are still able to spend.

"We would say also that the risk is not necessarily in the near term. Much of it we see is more in the 2023 area, largely because particularly with monetary policy, that acts with a lag, and the weight from that likely will be felt in early 2023 or beyond," Bovino said in the episode. "We did push up our recession risk to 30% at this point in time. Just last year, it was between 5% and 10%."

In the episode, the economist discussed her outlook for the U.S. economy and inflation, the possibility of a wage spiral and the Federal Reserve's plans to wind down its nearly $9 trillion balance sheet. She also discussed how the Fed likely will tighten monetary policy too much in its effort to get inflation under control and the likelihood of a recession occurring as the central bank tries to initiate a soft landing.

The yield curve inverted in early April with the 2-year Treasury yield trading at a higher rate than the 10-year Treasury yield. An inverted yield curve is often viewed a potential warning that recession lies ahead.

Bovino said she respects the yield curve as an indicator but noted the inversion last month only occurred for a few days. She said daily inversions have occurred close to 150 times in the past, without a recession developing in the next 12 months. The economist puts more stock into a monthly average inversion and suggested that it might need to occur for a second month to present a solid signal of an impending recession.

A recession occurs when the economy contracts for two consecutive quarters. The Commerce Department reported in late April that the U.S. economy unexpectedly shrank in the first quarter at a 1.4% annualized pace. Bovino acknowledged that any decline in economic growth is not good news. Consumer sentiment has also plummeted, but Bovino noted that consumer spending continues to grow double-digits year over year. However, elevated inflation means that consumers are not getting as much for their money.

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"Street Talk" is a podcast hosted by S&P Global Market Intelligence.

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In recent months, consumers have utilized some of the several trillion dollars of excess savings accumulated during the pandemic. That stockpile grew during 2020 and 2021 due to government stimulus, expanded unemployment benefits and reduced spending as many consumers remained at home.

"It's a cushion, and that's a real support for households as they get through this very, very painful time," Bovino said of excess savings. "People are really feeling the pain. And the good news is that, at least at this point in time, there is cushion."

The Fed recognizes the pain of higher inflation and plans to act aggressively to get prices under control, the economist said. She expects a trifecta of back-to-back 50-basis-point rate hikes in the upcoming Fed meetings in June, July and September and has not ruled out a 75-basis-point hike either. Bovino expects the central bank to raise the fed funds rate to over 3% by year-end 2022 and then hike rates one to two more times in 2023.

The Fed plans to shrink its balance sheet as well, starting with $47.5 billion in declines, per month, for three months. The central bank then plans to shrink the balance sheet by $95 billion per month. Bovino believes the central bank will stay at that pace to keep markets calm, noting that it will likely "drive the car around the block before they start to get on the highway."

Still, the economist does believe the Fed actions will increase the fed funds to close to 3.5%, which she believes is beyond the neutral rate.

"I think they're going to overtighten," Bovino said. "That to me sounds like an overshoot. We think the economy will slow, hopefully not go into recession, which we don't have in our base case."