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Business

US faces ‘L-shaped’ recession as Fed scrambles to tame inflation: analyst

By
Ariel Zilber
Published Aug. 2, 2022
Updated Aug. 2, 2022, 4:27 p.m. ET

The US economy will likely have to stay in recession for longer than anticipated in order to bring runaway inflation under control, according to a top analyst.

Zoltan Pozsar, the global head of short-term interest rate strategy at Credit Suisse Group AG, wrote a client note pushing back on widespread sentiment that the worst of inflation may be behind us and that the Federal Reserve will begin lowering interest rates.

Instead, the US may have to gird for a so-called “L-shaped” recession that will be deeper and longer than expected, according to Pozsar.

Pozsar cited the ongoing Russian invasion in Ukraine as well as disruptions to the supply chain exacerbated by intermittent COVID-related lockdowns in China.

Inflation has soared to levels not seen in four decades.
Inflation has soared to levels not seen in four decades. Getty Images

“War is inflationary,” Pozsar wrote. His note was earlier cited by Bloomberg.

“Think of the economic war as a fight between the consumer-driven West, where the level of demand has been maximized, and the production-driven East, where the level of supply has been maximized to serve the needs of the West.” 

Pozsar also cited restrictions on immigration and a decrease in mobility brought about by the pandemic as key factors that have resulted in a tight labor market.

As a result, Pozsar writes that the Fed may need to raise interest rates to either 5% or 6% and keep them there for a sustained period of time in order to cool down consumer demand so that it matches the tight supply.

Meanwhile, analysts at Goldman Sachs are warning investors against complacency while noting that the economy remains at high risk of falling into a recession.

“Looking at the re-pricing of cyclical assets in the US and EU, we think the market might have been too complacent too soon in fading recession risks on expectations of a more accommodative monetary policy stance,” Goldman analysts wrote.

The note was first reported by Insider.

Goldman analysts think investors could be mistaken in their belief that the Fed will stop hiking interest rates — and perhaps start to cut them as soon as next year in hopes of avoiding a recession.

Citigroup economists put the odds of a recession as high as 50%. Citi’s global chief economist, Nathan Sheets, said the current economic data constitute the Fed’s “worst nightmare.”

The Fed is trying for a "soft landing" -- hiking interest rates while trying to avoid tipping the economy into a recession.
The Fed is trying for a “soft landing” — hiking interest rates while trying to avoid tipping the economy into a recession. AFP via Getty Images

Sheets said the Fed is in a bind as it tries to combat both stubborn inflation worldwide as well as slowing demand.

“It’s really hard for central banks to fight that,” Sheets said. “I’m cautious to use the word, but it feels at the moment that we’re going through a period … [of] transitory stagflation.”

“Looking at the re-pricing of cyclical assets in the US and EU, we think the market might have been too complacent too soon in fading recession risks on expectations of a more accommodative monetary policy stance.”

Top economists such as Nouriel Roubini said the Fed must choose between tolerating high inflation and tipping the economy into a recession.

Last week, the Fed hiked its benchmark interest rate by 75 basis points — the second straight month it had done so — and the first time since 1994 that the central bank raised rates by 0.75% two months in a row.

The latest rate hike came two weeks after the federal government released data indicating that prices rose by 9.1% in June — the highest since November 1981.