US faces L-shaped recession as Fed scrambles to tame inflation

The U.S. economy will likely need to stay in recession longer than expected in order to rein in runaway inflation, according to a senior analyst.

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

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

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

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

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

Pozsar also cited immigration restrictions and a decrease in mobility caused by the pandemic as key factors that led to a tight labor market.

As a result, Pozsar writes that the Fed may need to raise interest rates to 5% or 6% and hold them there for an extended period to cool consumer demand to match limited supply.

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

“As for the repricing of cyclical assets in the US and EU, we believe the market may have been too complacent too soon to mitigate recession risks on expectations of more accommodative monetary policy. “wrote Goldman analysts.

The note was first reported by Insider.

Goldman analysts believe investors could be mistaken in thinking the Fed will stop raising interest rates – and possibly start cutting them as early as next year in hopes of avoiding a recession.

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

Sheets said the Fed was at an impasse as it tried to tackle both stubborn inflation around the world and slowing demand.

“It’s really difficult for central banks to fight this,” Sheets said. “I’m careful with the use of the word, but it feels like we’re going through a period right now… [of] transient stagflation.

“As for the repricing of cyclical assets in the US and EU, we believe the market may have been too complacent too soon to mitigate recession risks on expectations of more accommodative monetary policy. .”

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

Last week the Fed raised 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 has raised rates by 0.75 % two months in a row.

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