Why the U.S. could still see a 'run-of-the-mill' recession this year

The Fed has been trying to slow the U.S. economy without causing a recession, but it may not be possible. Stephanie Roth, J.P. Morgan Private Bank Senior Markets Economist explains why the U.S. could still see a "run-of-the-mill" recession this year.

Video transcript

- Also, as investors shift focus to the Fed's meeting next week, our next guest says that rates are likely to remain restrictive for the rest of the year but warns there's one catalyst that could slow down the economy. Stephanie Roth, JP Morgan Private Bank Senior Markets Economist joins us now. Great to have you here in studio with us.

STEPHANIE ROTH: Great to be here.

- So what's that one catalyst?

STEPHANIE ROTH: Well, so right now, you're seeing rates are restrictive territory. And most recently, business revenue for the US economy has actually slipped below the Fed funds rates. So what does that actually mean?

Business revenue or if I'm a business and I own a certain company and I'm thinking about investments, if my revenue expectations are lower than what I can get in cash, I'm going to be slowing down my investment. That's likely to really slow down the economy. There's been an under appreciation for the nominal interest rates in this economy and the fact that that's what needs to really get restrictive.

People have been focusing on real rates. It's really more about nominal interest rates. We're a nominal world.

- So explain to us what that means for people who don't-- nominal interest rates is adjust for inflation, right, is what we're talking about here. So where are we with the nominal rate right now, and where should we be?

STEPHANIE ROTH: Exactly. So nominal interest rates are now sitting at 5%. That's where the Fed funds rate is sitting around. Business revenue or really GDI, and that's a part of the GDP report that comes out, that's slowed to around 4 and 1/2.

So now you're at a place where interest rates that you can get on cash are actually below your revenue rate in the economy. So if you're planning ahead, why would you invest that cash if your revenue expectations are potentially below that? And the economic outlook is pretty uncertain.

- You're the second person that's brought up GDI this week, the importance of tracking GDI versus GDP. What is that for investors out there?

STEPHANIE ROTH: Sure. So GDP is the measure that many of us look at. It comes out a little bit sooner. And it tracks the spending side of the economy, how much are businesses and consumer spending.

GDI is meant to match that. But it's tracking-- it uses a little bit different source data, measures the income side, how much are business is bringing in an income, how much are consumer companies bringing in an income. They should match over time.

But what's unique is in the first quarter, GDI was a lot weaker than GDP. So it tells you maybe there's some cracks under the surface. Maybe there's some income from the business perspective that's looking a little bit softer. Profits looked a little bit weaker than the GDP data, you know, would have suggested. So there's just a bit of that mismatch there, which just gets investors looking at maybe some of the cracks that are hiding underneath the surface.

- Well, I think the question here comes back to magnitude, right? Because when you talk about why would I invest the money when interest rates are at this particular level, I mean, companies have been telling us that they're not going to be spending as much, right? They're cutting workers. They're cutting CapEx. This is the year of efficiency, et cetera, et cetera.

I guess, the question is how bad is it going to get? Is there indeed going to be a recession this year? How dramatic is it going to be? What are these tea leaves telling you?

STEPHANIE ROTH: Yeah, exactly. And so far, it's been very much at the margin. It's been the big tech companies that have pulled back. Now, it's likely to be the real economy that's likely to feel it.

So the service sector continues to add jobs. You look in the last payrolls report. Jobs that were added were 339,000. So there's still resilience in the real Main Street part of the economy. That's what's likely to slow down and why we do think the economy will slip into recession.

Base case is recession hits around the fourth quarter of this year, hard to get the timing exactly right. But that's our base case expectation. As for the magnitude, I think about it in terms of unemployment rates, just because it's a little bit more tangible.

So latest unemployment rate was 3.7%. I think that rises to about 4 and a half percent at the end of this year and then 5 and a quarter next year. So that's the consistent with a run-of-the-mill recession. We're sticking with a sort of normal recession rather than this concept of mild because that's hard to promise. And it's possible it could be just a more normal type of downturn.

- What does that mean for the employment situation as well as investors? Well, not even just investors, consumers out there who are trying to remain resilient. They're trying to also grapple with what their prospects for jobs are as well that are going to allow them to outlast the recession.

STEPHANIE ROTH: Yeah, and that's probably going to change at the margin over the course of this year. And that's what the Fed's trying to do. They're trying to slow down the world because they're trying to bring inflation down with it.

So to some extent, that's what the aim is if they weren't able to slow down the economy and bring down inflation, that would be a bigger type of problem. So the Fed is looking for the slowdown, certainly not hoping for a recession by any means. But it's possible recession will just be needed to get that last bit of inflation back down to closer to the 2%.

- We'll see what that looks like. And we'll keep in touch and check on more of these interesting indicators you're looking at. Stephanie, thank you.