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Why this banking giant says Fed strategy to quell U.S. inflation might lead to recession

Deutsche Bank became the first major financial institution to predict a recession

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A television screen on the floor of the New York Stock Exchange shows the rate decision of the Federal Reserve.

A television screen on the floor of the New York Stock Exchange shows the rate decision of the Federal Reserve on Wednesday, March 16, 2022. As the Federal Reserve signals its intent to continue aggressive interest rate hikes to battle ongoing record-high inflation, banking giant Deutsche Bank this week became the first major institution to warn that a U.S. recession may be in the making.

Richard Drew, Associated Press

As the Federal Reserve signals its intent to continue aggressive interest rate hikes to battle ongoing record-high inflation, banking giant Deutsche Bank this week became the first major institution to warn that a U.S. recession may be in the making.

On Tuesday, CNN reported the recession call — the first from a major bank — reflects growing concern that the Fed will hit the brakes on the economy so hard that it will inadvertently end the recovery that began just two years ago.

“We no longer see the Fed achieving a soft landing. Instead, we anticipate that a more aggressive tightening of monetary policy will push the economy into a recession,” Deutsche Bank economists led by Matthew Luzzetti wrote in the report.

In minutes from their policy meeting three weeks ago released Wednesday, Fed officials said that aggressive half-point rate hikes — rather than traditional quarter-point increases — “could be appropriate” multiple times this year.

At last month’s meeting, many of the Fed policymakers favored a half-point increase, the minutes said, but held off because of the uncertainties created by Russia’s invasion of Ukraine. Instead, the Fed raised its key short-term rate by a quarter point and signaled that it planned to continue raising rates well into next year.

Per CNN, although Deutsche Bank cautioned there is “considerable uncertainty” around the exact timing and size of the downturn, it’s now calling for the U.S. economy to shrink during the final quarter of next year and the first quarter of 2024, “consistent with a recession during that time.”

The good news is Deutsche Bank is not forecasting a deep and painful recession like the past two downturns.

Rather, the bank expects a “mild recession,” with unemployment peaking above 5% in 2024. That would still translate to considerable layoffs.

Some other major financial institutions, however, are more optimistic about the downstream impacts of the Fed’s expected series of interest rate increases.

Bloomberg News reported Goldman Sachs Group Inc. economists led by Jan Hatzius said in a report Monday that an economic downturn was “far from inevitable,” in part because consumers and companies are “flush” with cash.

“Our call for a recession in the U.S. next year is currently way out of consensus,” Deutsche Bank economists David Folkerts-Landau and Peter Hooper acknowledged in their report, adding, “We expect it will not be so for long.”

Higher rates from the Fed will heighten borrowing costs for mortgages, auto loans, credit cards and corporate loans. In doing so, the Fed hopes to cool economic growth and rising wages enough to rein in high inflation, which has caused hardships for millions of households and poses a severe political threat to President Joe Biden.

Many economists have said they worry that the Fed has waited too long to begin raising rates and that the policymakers might end up responding so aggressively as to trigger a recession.

Chairman Jerome Powell opened the door two weeks ago to increasing rates by as much as a half point at upcoming meetings, rather than by a traditional quarter point. The Fed hasn’t carried out any half-point rate increases since 2000. Lael Brainard, a key member of the Fed’s Board of Governors, and other officials have also made clear that such sharp increases are possible. Most economists now expect the Fed to raise rates by a half point at both its May and June meetings.

In a speech Tuesday, Brainard underscored the Fed’s increasing aggressiveness by saying that the central bank’s bond holdings will “shrink considerably more rapidly” over “a much shorter period” than the last time the Fed reduced its balance sheet, from 2017-2019. At that time, the balance sheet was about $4.5 trillion. Now, it’s twice as large.

Contributing: Associated Press