When will a recession come?

We still expect the delayed effects of monetary tightening and tighter credit availability to dampen economic growth. However, the enduring strength of the labor market prompted upward adjustments to our forecast for employment, real disposable income and consumption, shifting the expected start of the downturn closer to the end of this year. We also estimate a more modest peak-to-trough real GDP decline of 0.7%.

Since our previous monthly economic outlook, the United States has made progress evading the largest downside risks to our forecast. Congress passed legislation suspending the debt ceiling through the end of 2024, avoiding what would have been the first default in U.S. history. The financial sector has also avoided contagion that would trigger widespread instability in the banking system.

Data prints over the past month reveal a still-strong economy not yet on the brink of recession. As of May, the labor market has registered a 14-month streak of better-than-expected payroll gains. While small business hiring plans are trending down, the descent has been gradual and hiring plans remain historically elevated.

Consumers have yet to step off the gas, evidenced by April’s 0.5% jump in real consumer spending. Upward revisions to our forecast for payrolls and disposable income have pushed up our expectations for consumer spending through the end of the year.

As the tight labor market continues to buoy real incomes and fuel spending, price pressures are easing only gradually. As a result, we now expect slightly higher inflation over the forecast horizon, with the increase in the PCE deflator averaging 4.3% in 2023 and 2.7% in 2024.

Nonresidential investment has been bolstered by an influx of new projects in electric vehicle and semiconductor manufacturing; however, a tough environment for CRE will likely weigh on nonresidential investment in the quarters ahead. More broadly speaking, higher costs and lower business earnings in recent months are likely to put downward pressure on investment spending throughout the economy.

Fed Chair Powell and President Biden’s pick for Vice Chair, Fed Governor Jefferson, have each signaled that the committee may “skip” a rate hike at the June meeting to examine the extent to which credit tightening has already stifled demand. After June, we believe firm core inflation will compel the Committee to tighten policy further, with another 25 bps hike in July. This monetary policy path would produce a terminal rate in the range of 5.25% to 5.50%.

We anticipate the FOMC will start cutting in Q2-2024 once core inflation trends closer to the Committee's 2% target and material signs of labor market weakening start to emerge.

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