Is there going to be an economic recession?

The US CPI jumped 8.5 percent in March from 12 months earlier — the biggest year-over-year increase since December 1981.

Mr. Steve Barrow, Head of Standard Bank G10 Strategy, said he would feel the upcoming recession. His view is based on how much the Fed needs to bear down on demand in order to calibrate demand with the new, much reduced level of supply in the economy. The unique thing about the current situation is that the Fed faces an extremely uncertain supply situation thanks largely to COVID but also to some longer-term structural factors that we have talked about before, such as deglobalisation and deteriorating demographics in industrialised countries. In past periods of high inflation, in the 1990s or 2000’s, the Fed has not really had to worry about supply. As a result, it might have only taken a relatively modest tug on demand to bring any burgeoning inflation problem into check. But now, if supply is so much lower than it was before the pandemic, reducing demand modestly, as the Fed seems to be predicting, will be like pushing on a piece of string; inflation will remain elevated even if it is not up to the 8.5% level that we saw in the March CPI data yesterday.

By its own acknowledgement, the Fed can’t influence supply, and with supply so constrained, it might take a deep recession to bring about the sort of demand/supply balance that can bring inflation back to target. Of course, it might only require a mild recession, or perhaps no recession at all; just an elongated period of very low growth indeed.

What we do know is that it is important to look through much of the decline in annual CPI and PCE inflation that may occur in the future. If this reflects little more than base effects and the unwinding of some excessive price increases in certain categories, such as energy and used cars, it might be the case that demand remains too elevated compared to supply. What is important in a longer-term context for inflation are the bigger, slow-moving components of the CPI, such as shelter prices. For instance, shelter prices rose another 0.5% in the CPI data released on April 12, and as long as prices here stay around current levels, or increase further, as seems likely, it is difficult to see how inflation can return to target without some sort of much deeper economic downturn that breaks the back of some of these key inflation components. Annul inflation will undoubtedly come down, if only because of the base/energy type effects mentioned earlier.

In Mr. Steve Barrow’s view, what’s important is whether it stabilises back down near the 2% target in coming years, as the Fed predicts, or whether it stays stubbornly higher than 2%, as we expect. On this, there was another piece of interesting inflation data, but this time from the small business association, the National Federation of Independent Businesses. It showed that 72% of firms had reported higher prices in March, which is a record, and 50% still expect prices to climb further. That’s something we might expect if the economy were expected to fire on all cylinders with rampant demand.

The same survey showed that 49% were pessimistic about the economy over the coming year. That’s the worst reading from this survey; worse than during the pandemic and the global financial crisis. "It is saying something that small firms think prices will continue to surge when the economy is in as much danger as they seem to expect. It may also be a sign that a recession is likely and not just a theoretical requirement to rid the economy of inflation", Mr. Steve Barrow said.