As the Federal Reserve engages in its most aggressive monetary tightening in the coming months since the 1980s to fight inflation, the U.S. economy will head into a deep but brief recession by late 2023, Deutsche Bank AG economists warn.
The Fed has said that it will rate interest rates to a neutral level of 2.5%. However, it is more likely the Fed funds rate will move into the 5% to 6% range, Bloomberg reports, citing the Deutsche Bank report, released Tuesday.
A cap of 5% to 6% may be on the low end, the Deutsche Bank economists add: "We assume, conservatively, that a Fed funds rate moving well into the 5% to 6% range will be sufficient to do the job [of tamping down inflation] this time," wrote the authors, including Deutsche Bank Group Chief Economist David Folkerts-Landau.
"This is partly because the monetary-tightening process will be bolstered by the Fed balance-sheet reduction, which our U.S. economics team estimates will be equivalent to a couple additional 25 basis-point rate hikes."
These actions by the Federal Reserve will lead to financial upheaval that "will push the economy into significant recession by late next year," Folkerts-Landau wrote.
Unemployment will rise "several percentage points," the Deutshe Bank economists warn.
"We will get a major recession, but our strongly held view is that the sooner and the more aggressively the Fed acts, the less longer-term damage to the economy there will be," the economists add.
The Federal Open Market Committee is expected to raise rates by 50 basis points as well as to announce its plan for its $9 trillion balance sheet quantitative tightening, at its May 3-4 meeting next week. The Fed raised rates by 25 basis points in March.
Meanwhile, in a Monday note to investors, Morgan Stanley cautions that the S&P 500 is poised to fall sharply on investors' recession fears, sending stocks broadly into bear market territory, Fox Business News reports.
The S&P 500 is "ready to join the ongoing bear market," according to Morgan Stanley analysts, led by Michael Wilson.
In the past month, the S&P benchmark index has lost 6.6% in value. It is down 11.1% year to date.
"With defensives the latest big outperformer, they are now expensive, leaving very few places to hide," the Morgan Stanley analysts' note to investors says. "This suggests the S&P 500 will finally catch up to the average stock and enter a bear market.
"The market has been so picked over at this point, it's not clear where the next rotation lies," the Morgan Stanley note continues. "In our experience, when that happens, it usually means the overall index is about to fall sharply with almost all stocks falling in unison."
Goldman Sachs Group Inc. estimates that the chance of a recession in the U.S. economy in the next two years is 35%. Bloomberg Economics' recession probability model puts the likelihood of a recession happening by January 2024 at 44%.
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