Dive Brief:

• The U.S. economy will likely dip into a mild recession in early 2024 as consumer spending flags and the full force of the most rapid increase in borrowing costs in four decades chokes off growth, Fannie Mae said.
• “A modest contraction remains the most likely outcome as consumption continues to outpace incomes and previous monetary policy tightening works its way through the system,” Fannie Mae economists said in a report.
• Gross domestic product will probably shrink during the first nine months of 2024 before a fourth-quarter rebound in growth limits the full-year contraction to 0.2%, according to Fannie Mae.

Dive Insight:

Several headwinds threaten the effort by Federal Reserve officials to achieve a so-called soft landing, or slow economic growth enough to curb inflation to their 2% target without triggering a downturn and widespread layoffs.

Although real personal consumption jumped 0.6% in July compared with June, consumer spending will probably flag in coming weeks as households draw down excess savings during the pandemic, according to economists at Fannie Mae, the San Francisco Fed and other organizations. Consumer spending accounts for about 70% of economic growth.

A resumption of student loan payments next month and the 30% surge in the price of crude oil since June 27 pose additional threats to consumer spending.

Banks this year have consistently reported to the Fed plans to tighten credit standards, suggesting that the highest federal funds rate in 22 years has yet to take hold throughout the economy.

“The full effects of the cumulative tightening have yet to be felt,” the Organization for Economic Cooperation and Development said Tuesday in an economic forecast, noting that real interest rates in the U.S. are at the highest level since 2007.

“Monetary policy needs to remain restrictive until there are clear signs that underlying inflationary pressures are durably lowered, with near-term inflation expectations moderating further and excess resource pressures fading in labor and product markets,” OECD economists said.

At the same time, many economists remain confident that the central bank will navigate the economy away from recession.

“The odds of the Fed achieving a soft landing look much better than they did six months ago,” according to Simona Mocuta, chief economist at State Street Global Advisors.

GDP will likely grow 1% on an annualized basis from the fourth quarter through June 2024, according to a panel of economists convened by the American Bankers Association. The probability of recession next year is less than 50%, the ABA’s Economic Advisory Committee said last week.

“The battle against inflation is not yet won, so the Fed must remain vigilant,” according to Mocuta, chair of the advisory committee of economists from 14 large North American banks.

Signs of disinflation in recent months will probably prompt Fed policymakers on Wednesday to hold the main interest rate at a range from 5.25% to 5.5%, according to Mocuta and several other economists.

“There is a broad consensus that the Fed will not hike at the meeting this week, while maintaining a tightening bias in the forward guidance,” Ginger Chambless, head of research for commercial banking at JPMorgan Chase, said Monday in a research note.

Fed officials in economic projections released Wednesday will probably signal one additional interest rate hike this year, and one percentage point of cuts in the main rate in both 2024 and 2025, Chambless predicted.

The ABA’s committee of economists forecasts that the Fed will leave borrowing costs unchanged until May, when it will begin reductions that will leave the federal funds rate at a range of 4.25% to 4.5% by the end of next year.

“Given both demonstrated and anticipated progress on inflation, the majority of the committee members believe that the Fed’s tightening cycle has run its course,” Mocuta said.