Deutsche Bank Forecasts US Recession in 4th Quarter, Followed by Rate Cut

The U.S. economy will slip into a recession in the fourth quarter of 2023, and the Federal Reserve will respond with a rate cut in the following quarter, Deutsche Bank said in a new forecast.

The bank updated key economic projections in a research note last week after several developments on multiple fronts.

According to Deutsche Bank, the Fed will increase the terminal fed funds rate to 5.625 percent, up from its previous estimate of 5.1 percent. Economists cited persistent inflation pressures, better-than-expected economic data, and continued resilience in the labor market.

In recent weeks, Fed officials have signaled that they could become more aggressive in raising interest rates to accomplish a “sufficiently restrictive” monetary position, especially following hot inflation data.

This, Deutsche Bank stated, supports its baseline projection for a “moderate recession” instead of a soft landing. However, the financial institution delayed its timeline by one quarter: a recession to finish 2023 and the central bank’s first rate cut to start 2024.

“Stronger growth momentum, stickier inflation, and a more aggressive Fed that will need to tighten financial conditions, support our baseline expectation for a moderate recession rather than a soft landing. That said, firmer near-term strength in the US economy suggests that the timing of a recession is likely to be delayed,” Deutsche Bank economists said in a note.

“We have maintained our view of a moderate recession, with real GDP [gross domestic product] declining roughly 1.25 percent from peak-to-trough over the course of Q4 2023 through Q2 2024 and the unemployment rate rising about 2 percentage points in total. Both of these would be close to the early 1990s recession and mild relative to history.”

On the inflation front, the broad-based price pressures found in the January consumer price index (CPI) and producer price index (PPI) reports nudged the bank to upgrade its inflation forecasts for the rest of the year.

Economists anticipate a decline in the core CPI and the core personal consumption expenditures (PCE) price index, which leaves out the volatile food and energy sectors, to 3.2 percent and 3.3 percent, respectively, by year’s end.

The falling unemployment rate is seen peaking at 5.5 percent in the second quarter of 2024.

By comparison, the Fed’s Survey of Economic Projections (SEP) from December suggests 0.5 percent growth in GDP this year, a 4.6 percent unemployment rate, a core PCE inflation level of 3.5 percent, and a median fed funds rate of 5.1 percent.

Is the Recession Coming?

Many experts and organizations have delayed their recession forecasts to later this year.

A new survey of economists by the National Association for Business Economics (NABE) revealed that nearly half (48 percent) expect a recession later this year. Close to one-third expect an economic downturn in the April-to-June quarter, while a fifth believe it will start in the third quarter.

“Results of the February 2023 NABE Outlook survey continue to reflect significant divergence regarding the outlook for the U.S. economy,” NABE President Julia Coronado, president and founder of MacroPolicy Perspectives LLC, said in a statement. “Estimates of inflation-adjusted gross domestic product or real GDP, inflation, labor market indicators, and interest rates are all widely diffused, likely reflecting a variety of opinions on the fate of the economy—ranging from recession to soft landing to robust growth.”

In a series of tweets last week, David Rosenberg, the chief economist and strategist at Rosenberg Research, warned that the country is heading toward a recession and dismissed assertions of a “no landing” as a “hoax.”

“The ‘no landing’ narrative is the biggest hoax Wall Street economists have peddled since ‘global decoupling’ in 2008,” he wrote on Twitter. “Follow the leading indicators, not the Pied Pipers.”

He also alluded to the minutes from this month’s Federal Open Market Committee (FOMC) policy meeting that referred to a recession four times, the most since June 2020.

According to a paper (pdf) co-authored by former Fed Governor Frederic Mishkin, the U.S. central bank will be unlikely to defeat inflation without having to further raise interest rates, resulting in a recession.

“We find no instance in which a central-[bank] induced disinflation occurred without a recession,” the paper stated. “Even assuming stable inflation expectations, our analysis casts doubt on the ability of the Fed to engineer a soft landing in which inflation returns to the 2 percent target by the end of 2025 without a mild recession.”

The economists noted that the Fed will need to tighten policy even more to accomplish its 2 percent inflation objective by the end of 2025. However, Treasury Secretary Janet Yellen envisions a “soft landing,” suggesting that the central bank will beat inflation without triggering a downturn.

“I see a soft landing as being a possible outcome, and the one that I hope we will be able to achieve,” Yellen said at a briefing in India on Feb. 24. “The economy is fundamentally in good shape, and inflation is coming down if you measure it on a 12-month basis.”

The Atlanta Fed Bank’s GDPNow model estimate suggests 2.8 percent growth in the first quarter, up from 2.7 percent.

Meanwhile, a growing number of Fed officials, including St. Louis Fed Bank President James Bullard and Cleveland Fed Bank President Loretta Mester, have discussed a higher policy rate to lock in a disinflation trend.

For now, the markets expect a quarter-point rate increase at March’s FOMC meeting, but the odds of a 50-basis-point boost are rising, data from the CME FedWatch Tool show.