A U.S. recession is going up by the day and a soft landing by the Fed is unlikely, says Wells Fargo’s head of macro strategy

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The odds of a recession are increasing, with the US economy likely to fall into a slump in 2023, according to Wells Fargo head of macro strategy, Michael Schumacher.

In a Thursday interview with CNBC, Schumacher pointed to a range of factors including historic inflation, spiking mortgage rates, commodity prices, the pandemic, and the war in Ukraine that all make the Fed’s path forward difficult to navigate. 

All of these factors have led Schumacher to forecast a 50% chance of recession by late 2023. 

“The idea of having a soft landing was always going to be really challenging, and when you think about the additional complications…it makes it super tough for the Fed to calibrate,” Schumacher said. 

The strategist also noted the probability of the Fed overshooting with its plans for raising interest rates is also getting higher each day, and that the market is not prepared to handle more aggressive rate hikes. 

“There’s not really a great path for the Fed to try and limit recession risk, as far as going big, going early, going 50 basis points in May…I don’t know if it really changes the ultimate question of how you calibrate all these issues that are coming together.” 

Earlier this week, top economist Mohamed El-Erian made similar comments, noting that he anticipates the Federal Reserve will make a policy mistake. The US central bank, El-Erian said, is facing a lose-lose scenario of either high inflation or a recession. 

Markets have fluctuated since the Fed first suggested it would hike interest rates, but mixed signals from Fed Chair Jerome Powell as well as external factors like the war in Ukraine are complicating factors for investors. 

Even if the Fed moves forward with a 50 basis-point hike in May as it signaled that it might, it wouldn’t change the calculus for a coming recession, according to Schumacher. 

“Does throwing in a 50 [basis point hike] or two really change the calculation? I think it doesn’t.”

How does this affect Mexico?

Recession and stagflation: the harsh economic reality in Mexico

It has been difficult for Mexico to start the engine of economic growth.

In the last quarter of last year, the economy suffered a contraction of 0.1%, according to preliminary data announced on Monday by the National Institute of Statistics and Geography (Inegi).

In this way, the economy would add two quarters in a row with red figures, which in the jargon of experts is known as “technical recession”.

Although the term has the flavor of a brutal fall, the truth is that economists usually make the difference between a technical recession and an economic crisis with all its letters.

The latter implies a profound weakening of the main macroeconomic indicators such as, for example, employment, price levels, domestic consumption, the payment capacity of economic agents, or the level of production.

In this sense, the economic crisis not only includes low or negative growth but also implies high financial instability.

Mexican workers

Mexico is not in a crisis, but neither is it going through a good time after the economic consequences left by the pandemic.

Disruptions in supply chains, the fourth wave of covid-19, high inflation, the effects of new legislation on subcontracting and uncertainty among entrepreneurs are some of the reasons that explain the economic slowdown.

In 2021, the country’s Gross Domestic Product (GDP) grew 5%, a step forward, but at the same time an insufficient recovery to compensate for the deep drop of 8.4% in 2020.

Mexico’s economy showed “clear signs of weakness in the second half of 2021,” wrote Renzo Merino, an analyst at international consultancy Moody’s.

“A persistent negative dynamics in investment points to economic growth in 2022 being much weaker than projected by the authorities,” it added.

The government of Andrés Manuel López Obrador (AMLO) has maintained an austere fiscal policy compared to other governments in the region that approved large fiscal aid packages during the pandemic to support the most vulnerable families and businesses.

Slow growth

With fiscal spending under control and a policy of raising interest rates by the central bank, expectations of faster growth have given way to the idea of ​​much more gradual growth this year.

Much will depend on external factors such as the evolution of covid-19, the crisis in global supply chains, the shortage of semiconductors to manufacture cars, the price of oil and other commodities, in addition to the direction taken by the two largest economies. largest in the world: the United States and China.

Organizations such as the International Monetary Fund (IMF) project that this year the Mexican economy would grow around 2.8%, although some economists have begun to slightly lower their forecasts.

“We doubt that Mexico will remain mired in recession for much longer,” says Nikhil Sanghani, an economist specializing in Latin America at the British consultancy Capital Economics.

Automotive production plant in Mexico

“But the recovery will continue to be slow in the coming quarters,” he points out. His projection is that the growth of the Gross Domestic Product (GDP) for this year could slow down to 2%.

If that forecast comes true, he adds, it would be a sign that “Mexico’s economy will continue to lag behind in the region this year and that production will be somewhat far from its pre-pandemic trend.”

A few days ago, the undersecretary of the Treasury of Mexico, Gabriel Yorio, stated that referring to a “technical recession” of the local economy at this time was not the most accurate.

“Speaking of a technical recession, we feel that it is not really capturing the economic dynamics that is being observed due to the effects of the pandemic and especially due to the effects of these supply shocks that the world is experiencing,” he pointed out.

Stagflation?

Yorio ruled out that Mexico is currently in a process of stagflation (a scenario of little economic growth with high levels of inflation), as some economists have warned.

“We do not agree that we are in such a situation,” he said.

But some economists see a high probability that Mexico and other Latin American countries will face a scenario of stagflation.

woman with baby

The country is trying to control an inflation that reaches 7.13%, much more than double the goal that has been set.

The increase in the cost of living is part of an inflationary wave that is sweeping the planet and that in countries like the United States has reached 7%, the highest in almost 40 years.

To try to stop it, the central bank has raised interest rates in Mexico progressively and many economists project that it will continue on the upward path.

Gross fixed investment has seen a drop since mid-2018, accelerating from the pandemic and López Obrador’s policy that seeks to grant state energy companies a monopoly in the market. During his administration, proposals have been sent to reform the electricity sector and, more broadly, the energy sector, to limit the participation of private companies. López Obrador also seeks to classify minerals such as lithium, essential in the new electrical technologies free of fossil fuels, as “strategic” and under the control of the State. During his government, in addition, permits and licenses have been frozen for renewable energy companies.

This has generated uncertainty in the private sector, undermining the performance of the economy. “Of the four GDP variables, for this year exports will decrease, consumption will contract, gross fixed investment will grow slightly, so public investment must be executed based on programmed public spending,” says José Ignacio Martínez, from the Laboratory of Commerce, Economy and Business (LACEN) of the UNAM. “LACEN forecasts that in 2022 the growth of Mexico will be 2.5% with a downward expectation of one percentage point.”

“The Government must shield the internal market so that consumption flows. Confidence must be provided to the investor, certainty to the entrepreneur and security to the consumer to cushion the reduction in GDP by 2022″, points out the economist.

Mexico Daily Post