Dive Brief:

• Rapid monetary tightening and an unsustainable pace in consumer spending point to “stalling economic growth” and the start of a modest recession during the fourth quarter, Fannie Mae said Monday.
• “Fundamentally, we still see an economy in its late-cycle stage,” Fannie Mae said in a forecast. “The current pace of consumer spending remains unsustainable given current income levels and, to date, has been supported by drawing down pandemic-related savings and tapping into increasing debt.” Consumers drive about 70% of economic growth.
• Fannie Mae upgraded its forecast for 2023 economic growth to 0.1% from minus 0.3% while downgrading its projection for next year to 0.8% from 1.2%. It predicts the economy will shrink 1.5% during the fourth quarter and 0.7% during the first quarter of 2024.

Dive Insight:

Predictions of recession persist amid conflicting signs of what lies ahead for the economy, including indications of an unusually strong labor market and a tightening credit squeeze following stress in the banking sector in March.

“Mixed data has painted a muddled picture of macroeconomic conditions in recent months, though a recession remains the most likely outcome of the rapid tightening of monetary policy and late-stage business cycle dynamics,” Fannie Mae said. In a forecast last month, Fannie Mae predicted that a downturn would start during the third quarter.

A springtime surge in job gains persisted last month as employers hired 339,000 workers and wage growth — while slowing from a 4.9% annual rate a year ago — rose 0.3% during the month and a still-strong 4.3% during the past 12 months.

The economy will likely grow 1.9% this quarter, an improvement from the estimated 1.3% increase during the first quarter, according to the Federal Reserve Bank of Atlanta.

Also, consumer sentiment surged 8% in June to its highest level in four months, according to a University of Michigan survey.

“Sentiment is now 28% above the historic low from a year ago and may be resuming its upward trajectory since then,” Joanne Hsu, the university’s director of consumer surveys, said in a statement. The improvement reflects “greater optimism as inflation eased and policymakers resolved the debt ceiling crisis.”

At the same time, some data suggest a downturn lies ahead. The Conference Board’s Leading Economic Index fell 0.7% percent in May in its 14th straight monthly decline.

Slowed by rising interest rates and persistent inflation, the economy will probably shrink from the third quarter to the first quarter of 2024, the Conference Board said.

“The recession will likely be due to continued tightness in monetary policy and lower government spending,” Justyna Zabinska-La Monica, senior manager with business cycle indicators at the Conference Board, said in a statement.

A pullback in credit, falling bank lending and shrinking money supply will undermine both business investment and hiring, Fannie Mae predicted. The result: Consumers will curb spending and choke off economic growth.

Consumer “sentiment remains low by historical standards as income expectations softened,” Hsu said. “A majority of consumers still expect difficult times in the economy over the next year,” Hsu said.

The Fed, seeking to slow inflation, will probably sustain high borrowing costs longer than investors initially expected, Fannie Mae Chief Economist Douglas Duncan said in a statement.

The central bank on June 14 paused its most rapid reduction in stimulus in four decades even as Fed officials raised their median projection for the federal funds rate at the end of the year to 5.6% from 5.1% in March. The central bank’s main interest rate currently ranges from 5% to 5.25%.

In another median estimate, Fed officials forecast that their preferred measure for inflation — the core personal consumption expenditures price index — will end the year at 3.9%, an increase of 0.3 percentage points from their forecast in March.

Core PCE rose in April at a 4.7% annual rate, well above the central bank’s 2% target. Fannie Mae predicts core PCE will fall to 3.7% during the fourth quarter.

Fed policymakers in recent weeks have identified the strong labor market as a leading cause of high price pressures.

“The Fed will maintain its restrictive monetary policy stance until it is abundantly clear that inflation pressures from the labor market have eased,” Fannie Mae said. “That evidence is unlikely to appear until a recession is already unavoidable, making the question of a downturn more a matter of ‘when’ than ‘if.’”

Policymakers will increase the federal funds rate to 5.4% next quarter before reducing it to 4.9% in the first quarter of 2024, according to Fannie Mae.